Trade deficits and jobs: What’s the worst case?

If you’ve read books like Pop Internationalism you know that international trade should not reduce employment.  Some are fooled by the GDP equation, which might seem to imply that net exports are a problem:

GDP = C + I + G + (X-M)

In fact, a trade deficit implies an equal sized surplus of investment over saving.  So a trade deficit does not reduce GDP.

There is one point that most skeptics are willing to accept—trade is not a problem if imports are balanced by exports.  This post is aimed at people who have one of two concerns:

1. Perhaps economic theory is wrong and trade deficits do somehow lead to lower employment.

2. Perhaps trade deficits don’t reduce the overall employment level, but they reduce employment in the tradable goods sector.

I don’t agree with these concerns, but I’d still like to take them seriously.  Consider the following question under the assumption that economists like me are wrong, and trade imbalances really do cost jobs.  The question is:

How many jobs has America lost over the past thirty years, in the worst case where jobs lost in the tradable sector are not offset by jobs gained in non-tradables?

In other words, what is the worst case for trade?

In 1985:Q4, the US trade deficit was 2.996% of GDP

In 2015:Q4, the US trade deficit was 2.865% of GDP

So the trade deficit has shrunk slightly over the past 30 years.  This means the answer to the previous question is:

In net terms, zero jobs have been lost in the tradable goods sector, as a result of trade deficits, over the past 30 years.  Whatever jobs losses have occurred has been due to other factors, such as technological progress.

Whatever has been reducing employment of tradable goods workers over the past 30 years, it hasn’t been trade.

In fairness, in the 3 decades before 1985:Q4, the trade deficit increased by 3% GDP.  So if you believe that trade deficits cause unemployment, then you might argue that workers were negatively affected during that earlier period.  I don’t believe that, I’m just saying that if you do believe that trade deficits cause unemployment, that’s the period you should be focusing on.  And even if I am wrong, obviously a 3% of GDP rise in the trade deficit doesn’t explain why the manufacturing sector has gone from over 30% of workers in the mid-1950s to about 8% today.

So if trade deficits aren’t a problem, are there any other channels by which trade could be a problem?  Yes.  Trade might affect income equality, reducing the relative wage of workers in the tradable goods sector.  That might reduce the labor force participation rate of workers in the tradable goods sector.  But again, that would have nothing to do with the trade deficit. Indeed it should be equally true of Germany, a country with a huge trade surplus.

PS.  I have a new post on China trade over at Econlog.

 


Tags:

 
 
 

46 Responses to “Trade deficits and jobs: What’s the worst case?”

  1. Gravatar of Matt Waters Matt Waters
    4. March 2016 at 13:26

    This post is very coincidental with Krugman’s post criticizing Romney’s criticism of 35% tariffs.

    http://nyti.ms/1TYoCpf

    I was interesting in your thoughts. Krugman agrees that a trade war decreases productivity and real GDP. But I’m not sure lower real GDP growth wouldn’t cause a recession. If the Fed slavishly targets 2% inflation, could declining real GDP still cause unemployment? It seems like it could from AD/AS curves, but I don’t have good enough mental traction of AD/AS to be sure.

  2. Gravatar of E. Harding E. Harding
    4. March 2016 at 13:32

    “I think a majority would also acknowledge that China trade somewhat lowered the cost of living, relative to no trade with China.”

    -You have to add “given a constant NGDP” into that for it to make sense. I am fully willing to state that trade with China had an inflationary impact on Mexico by reducing aggregate supply relative to counterfactual. Not sure about the U.S., though. It’s possible that the China trade might have had an inflationary impact on the U.S. by boosting the price of oil and other commodities, but the influx of manufactured goods from China had a clear deflationary impact on the U.S.

  3. Gravatar of E. Harding E. Harding
    4. March 2016 at 13:39

    @Matt Waters

    -Sumner in his book shows Smoot-Hawley did indeed strongly contribute to the Great Depression.

    And Krugman has a very bizarre definition of “recessions”. Either he knows nothing about international trade, or he is being intentionally misleading.

  4. Gravatar of Matt Waters Matt Waters
    4. March 2016 at 13:45

    On the trade deficit argument:

    1. Balance-of-payments does say any trade deficit is offset with investment. So it doesn’t make sense for Mexico to pay for a wall to keep their $58 bn of “free money.” Mexico would be losing the money outright to pay for the wall, while the trade deficit is an economic exchange.

    2. However, since the 60’s, cost of trade has gone down significantly if one includes the gains from containerization. If you look at trade like people are looking at computers now, the rewards could be very unequal. And that’s what we have seen.

    A post of yours a few years ago showed that the higher capital share of GDP is due to depreciation. When people are worried about inequality, it’s mainly inequality between wage earners. So both trade and technology could have very unequal benefits. And I’m not sure what could or should be done about it.

  5. Gravatar of Matt Waters Matt Waters
    4. March 2016 at 13:45

    Thanks Harding. I’ve got Sumner’s book on my kindle, but I need to set aside the time to read it.

  6. Gravatar of Aaron W Aaron W
    4. March 2016 at 14:00

    How much does the US dollar’s use as a reserve currency contribute towards a persistent trade deficit of around 3% of GDP? I’m not really an expert on this, so I was curious how much that might have an impact.

  7. Gravatar of K K
    4. March 2016 at 14:07

    Trade deficit is a rate not a level — couldn’t it be that changes in the ‘trade debt’ is hurting jobs and so the fact that the deficit is constant is not actually evidence of any lack of harm over that period? That ~3% a year could be devastating whether or not it shifts to ~2% or ~4%.

    I’m not saying that it was harmful, I don’t. I merely think that your argument is unlikely to sway those who disagree when there is such a clear flaw.

  8. Gravatar of jonathan jonathan
    4. March 2016 at 14:31

    Which was worse for low-skilled workers, free trade or free capital flows?

    Suppose that we think there are three factors of production: capital, labor, and skilled labor.

    Suppose there are 4 sectors: labor-intensive nontradeables (services), labor-intensive tradeables (clothing), capital-intensive tradeables (manufacturing), skill-intensive (partially tradeable?).

    Given that the US is relatively capital and skill-rich compared to ROW, you would think that free trade would lead to importing clothing and exporting manufacturing. Not necessarily so bad for unskilled workers (I guess this is the Germany strategy?).

    But instead, it seems that unskilled workers are doing very badly. Why is that? It seems the problem is that our unskilled manufacturing sector hasn’t grown as you might have expected.

    I’m not sure why this is so. Are we not as capital-rich as we thought, due to free capital flows? Or we have the wrong mix of capital for low-skilled manufacturing?

    Why hasn’t Germany had this problem, or are they just a weird outlier?

    I’m genuinely curious here. I’m no expert on trade.

    (My understanding is that we do a fair amount of high-skilled manufacturing.)

  9. Gravatar of ssumner ssumner
    4. March 2016 at 15:19

    Matt, Krugman’s wrong, protectionism can cause a recession if the central bank is targeting inflation, or if it is targeting interest rates.

    Harding, You said:

    “You have to add “given a constant NGDP” into that for it to make sense.”

    Just the opposite. It makes no sense if NGDP is constant.

    Aaron, I’m not certain. It was also the world’s reserve currency in the 1960s, when we had a trade surplus. It might play some role, but it’s not obvious to me.

    Jonathan, You asked:

    “Why hasn’t Germany had this problem, or are they just a weird outlier?”

    Why hasn’t Germany had what problem? They’ve usually had higher unemployment than the US in recent decades, and very slow growth in wages (at least since 2004.)

  10. Gravatar of E. Harding E. Harding
    4. March 2016 at 15:23

    “Just the opposite. It makes no sense if NGDP is constant.”

    -Huh?

    Good point on Germany.

  11. Gravatar of ssumner ssumner
    4. March 2016 at 15:24

    K, I think you mean it’s a flow not a stock. But so is GDP. How does that affect my argument?

  12. Gravatar of Jerry Brown Jerry Brown
    4. March 2016 at 15:34

    Professor, you say that a trade deficit implies an equal surplus of investment over savings and therefore does not reduce GDP. I am lost here and am not seeing the linkage. Actually, the only thing I can come up with is that this surplus of investment is in the form of unwanted inventory accumulation, which might lead to reduced output and employment in the next GDP measurement period. But that is obviously Not what you are saying about trade deficits.

  13. Gravatar of Benjamin Cole Benjamin Cole
    4. March 2016 at 15:42

    Intellectually, Scott Sumner is correct on international trade.

    On a practical level, one can look at export-oriented nations such as South Korea, Japan and China and note their economies boomed.

    There is also the non-PC case of South Africa during trade sanctions, during which SA commercialized a process to convert coal to oil, and deprived of weaponery, developed c an industry and became an arms exporter.

    Arguments are constantly blurred in this arena. For example, in high-tech Silicon Valley they say we need to import more skilled workers to keep industry here in the United States. That implies that keeping industry in the United States is a worthy goal. The oil industry often speaks of the jobs and income connected to producing oil domestically, rather than just importing oil.

    I can see why voters have mixed sentiments about free trade.

  14. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    4. March 2016 at 16:07

    Ask the man who knows about trade;

    https://web.archive.org/web/20061207071233/http://donaldtrump.trumpuniversity.com/default.asp?item=98255

    ———–quote———-
    Outsourcing Creates Jobs in the Long Run

    by Donald J. Trump
    Chairman, Trump University

    We hear terrible things about outsourcing jobs–how sending work outside of our companies is contributing to the demise of American businesses. But in this instance I have to take the unpopular stance that it is not always a terrible thing.

    I understand that outsourcing means that employees lose jobs. Because work is often outsourced to other countries, it means Americans lose jobs. In other cases, nonunion employees get the work. Losing jobs is never a good thing, but we have to look at the bigger picture.

    Last year, Nobel Prize-winning economist Dr. Lawrence R. Klein, the founder of Wharton Econometric Forecasting Associates, co-authored a study that showed how global outsourcing actually creates more jobs and increases wages, at least for IT workers. The study found that outsourcing helped companies be more competitive and more productive. That means they make more money, which means they funnel more into the economy, thereby, creating more jobs.

    I know that doesn’t make it any easier for people whose jobs have been outsourced overseas, but if a company’s only means of survival is by farming jobs outside its walls, then sometimes it’s a necessary step. The other option might be to close its doors for good.
    ————endquote———-

  15. Gravatar of TravisV TravisV
    4. March 2016 at 17:18

    [Sigh] At G20, China just announced. 3% budget deficit target for 2016……

  16. Gravatar of Doug M Doug M
    4. March 2016 at 17:47

    I am with you that international trade does not cause unemployment.
    However, I will recite an argument that was made when I was a student in the late 1980’s.

    If there is a trade imbalance, then and equal and opposite investment flow. Foreign investors are buying America’s productive resources. And overtime will be acquiring an ever greater share. Foreign investors are staking a claim to our future wealth they they would not be able to do if only more people would buy American.

    On the flip side, what one of my profs said. They send us a car. We sent them a slip of paper. They send us more cars and send them more paper. This sounds like a winning deal.

  17. Gravatar of Ray Lopez Ray Lopez
    4. March 2016 at 17:59

    Good post by Sumner, who shines when he sticks to micro not macro. Some comments: the accounting identity Sumner refers to: Savings = Investment + Govt + (Exports – Imports) is true, but misleading in that “government” is considered a form of “public savings” (when in surplus, but government inefficiency insures there’s no such thing even when there’s a surplus) and Exports-Imports loses meaning when multinationals are involved, since these classifications are largely arbitrary. But in theory Sumner is correct.

    E. Harding informs us that “Sumner in his book shows Smoot-Hawley did indeed strongly contribute to the Great Depression”, which, if true, is rebutted by this excellent book: “Peddling Protectionism: Smoot-Hawley and the Great Depression” by econ prof Douglas A. Irwin (2011). Has Sumner never read Irwin’s book? Another reason I won’t buy Sumner’s book.

    @jonathan – Sumner did not answer your question, but if you Google Krugman’s work, you’ll find the answer to your problem. It’s that rich countries trade among each other even if there’s no ‘comparative advantage’. Example: the USA is a large importer of energy, and a large exporter too.

  18. Gravatar of TheNumeraire TheNumeraire
    4. March 2016 at 18:07

    Doug M,
    It is not a given that a trade deficit would cause foreigners to own an ever larger share of U.S. wealth and productive assets. The market value of U.S. productive capital has grown faster than the annual trade deficit over the 40 years and from a much larger initial base figure.

    Furthermore, not all export income earned internationally from U.S. imports is sourced to foreigners, a large share is sourced from foreign-subsidiaries of companies owned by American investors, pension funds etc.

  19. Gravatar of E. Harding E. Harding
    4. March 2016 at 18:09

    Ray, I don’t know how you can live with yourself with such arrogant ignorance.

  20. Gravatar of dtoh dtoh
    4. March 2016 at 18:10

    Not to make an obvious point, but the problem is not the aggregate impact. It’s the impact on individual firms and workers.

  21. Gravatar of Ray Lopez Ray Lopez
    4. March 2016 at 19:55

    OT—does Sumner believe unemployment is a function of price and wage rigidities? I think so…ergo, what follows is relevant, though Sumner is not a Keynesian but a close cousin, a monetarist.

    Micro vs. Macro, Lars Pålsson Syll [Malmö University, Sweden] (2014):
    … there are also, unfortunately, a lot of neoclassical economists out there who still think that price and wage rigidities are the prime movers behind unemployment. What is even worse is that some of them even think that these rigidities are the reason John Maynard Keynes gave for the high unemployment of the Great Depression. This is of course pure nonsense. For, although Keynes in General Theory devoted substantial attention to the subject of wage and price rigidities, he certainly did not hold this view. That’s rather the view of microfounded DSGE modelers, explaining variations in employment (and a fortiori output) with assuming nominal wages being more flexible than prices – disregarding the lack of empirical evidence for this rather counterintuitive assumption. Since unions/workers, contrary to classical assumptions, make wage-bargains in nominal terms, they will – according to Keynes – accept lower real wages caused by higher prices, but resist lower real wages caused by lower nominal wages. However, Keynes held it incorrect to attribute “cyclical” unemployment to this diversified agent behaviour. During the depression money wages fell significantly and – as Keynes noted – unemployment still grew. Thus, even when nominal wages are lowered, they do not generally lower unemployment.

    Note wages fell but unemployment still rose in the Great Depression, proving it was not a monetary phenomena at all (unless you take the unprovable position they did not fall fast enough), but rather a function of structural changes (bank failures, transition from steam to electrical age) and mass psychology (panic, herd behavior).

    @E. Harding – put up or sit up. Insults won’t do.

  22. Gravatar of Jerry Brown Jerry Brown
    4. March 2016 at 21:40

    Thanks Doug M. Your comment broke my brain block. I think I see now how a trade deficit does imply an equal and opposite investment flow. But isn’t the key word here “imply”? As in it is not necessary for the counterpart to invest (which I’m understanding as buying assets from) in the country running the trade deficit. They could instead just hold onto those funny slips of paper as part of a policy of building currency reserves or something. In that case a trade deficit would lower GDP as far as I can see. And even if they bought assets like real estate or artwork or anything previously created that had value instead of holding that currency you would have to assume that the sellers of those assets would spend that immediately in order to not change overall employment. Anyways, I also was an econ student in the late 80’s and am happy for any refresher lessons.

  23. Gravatar of Ray Lopez Ray Lopez
    4. March 2016 at 21:52

    @Doug M – “On the flip side, what one of my profs said. They send us a car. We sent them a slip of paper. They send us more cars and send them more paper. This sounds like a winning deal.” – there are no free lunches. People are not stupid. Money is largely neutral. Reexamine what the professor said in view of these remarks.

    “There is always an easy solution to every human problem – neat, plausible and wrong” -H. L. Mencken

  24. Gravatar of Jerry Brown Jerry Brown
    4. March 2016 at 22:25

    Ray, China has over 3 trillion dollars worth of foreign currency reserves. Japan has over a trillion. They have been sending people stuff in exchange for slips of paper for quite a while.

  25. Gravatar of Ray Lopez Ray Lopez
    4. March 2016 at 22:35

    @Jerry Brown – you misread the statement by Doug M. He implies the ‘slips of paper’ is a bad deal for one party (presumably the country making the cars). I’m saying that’s not necessarily the case (essentially I agree with your position).

  26. Gravatar of Jerry Brown Jerry Brown
    4. March 2016 at 23:09

    Ray, I think you are right that accepting slips of paper in exchange for real goods is not necessarily bad for a country. But that is because that country may be trying to employ its own people while developing industries. And there is probably a good chance that those slips of paper can be exchanged in the future for actual goods at somewhere near their original exchange rate. But what I am trying to understand is how a trade deficit with a country that is intent on accumulating these slips of paper would not reduce GDP and employment in the country with the trade deficit. Can you help me there?

  27. Gravatar of Michael Michael
    5. March 2016 at 02:27

    Jerry,
    assume the central bank offsets the increased currency demand because it is targeting, e.g., inflation or NGDP. So, if the exporter ‘sits’ on the earned currency, the ‘missing’ demand is created for/by someone else. (Of course, the receiver of the newly created money will have a liability, while the exporter who hasn’t spent keeps the asset, so, in first approximation, no wealth is transferred — the balance sheet still works out. This may change if, as I’d assume, the investment is put to good use, in which case real wealth is created — but not for the keeper of the cash.)
    Otherwise, if the central bank does NOT offset, the exporter’s behavior (withdrawing currency from circulation, making it scarcer) is deflationary. That means, te GDP deflator gets <1, i.e. the same NGDP translates into a higher RGDP, exactly compensating the loss from the 'missing' investment
    Well, not exactly. I'd assume missing monetary offset will have negative real consequences, but that's really the central bank's doing, not the cash-hogging exporter's

  28. Gravatar of Steve Steve
    5. March 2016 at 06:27

    1. Ben makes a good point. Tech execs want to bring people in to keep jobs here. I also saw a Silicon Valley VC argue we need subsides for green tech, so that the US wins at green tech and not China. Why is this strategically important? Business execs are hypocritical. They hate tariffs, but loovvvve subsidies.

    2. Community impact is large. When 1400 lose jobs, property prices go to zero, people are trapped, friends and family are in the same boat and can’t help. In 5 years they will all be on welfare taking heroin and getting mocked by elites.

    3. Have you written on ex-im? No opinion, but Indiana congressman is in hot seat for spending political capital on ex-im “to create jobs” only to watch jobs go to Mexico anyway.

    4. It seems tech ip plays a role here. Mexico exports air conditioners, so it can afford to import ads from Facebook. 1400 lose jobs, so Mark Zuckerberg can get even richer. There’s your income inequality impact.

  29. Gravatar of Christian List Christian List
    5. March 2016 at 06:41

    “So if trade deficits aren’t a problem, are there any other channels by which trade could be a problem? Yes.”

    In this context I found a paper by Autor, Dorn and Hanson to be interesting:

    “As a result, the authors found in a 2013 paper, competition from Chinese imports explains 44% of the decline in employment in manufacturing in America between 1990 and 2007. For any given industry, an increase in Chinese imports of $1,000 per worker per year led to a total reduction in annual income of about $500 per worker in the places where that industry was concentrated.”

    http://www.economist.com/news/finance-and-economics/21690073-globalisation-can-make-everyone-better-does-not-mean-it-will-trade

    The journalist in The Economist also writes “The costs of Chinese trade seem to have been exacerbated by China’s large current-account surpluses…”

    But he does not say how and why.

  30. Gravatar of Steve Steve
    5. March 2016 at 06:47

    Trump proposes adding tariffs, and gets torn apart by business community ‘establishment.’

    Cruz proposes eliminating subsidies, and gets torn apart by business community ‘establishment.’

    Are we missing something here? The raw power of being an insider?

  31. Gravatar of Ray Lopez Ray Lopez
    5. March 2016 at 06:51

    @Jerry Brown 4. March 2016 at 23:09 – that’s a good question, it broadly goes to why the US dollar remains so strong despite persistent trade deficits in the US. However, your question “But what I am trying to understand is how a trade deficit with a country that is intent on accumulating these slips of paper [CHINA] would not reduce GDP and employment in the country with the trade deficit [THE USA]”, is more narrow and can be easily answered as: to date no evidence that China’s cannibalizing US manufacturing has negatively impacted the USA. But, long term, a certain economist (among others) known as Vaclav Smil (his books are found free at the usual pirate sites like KAT) or, more generally, authors like economist Dambisa Moyo “How the West Was Lost” (e-book also pirated) speak to a coming very abrupt decline in the West due to the factors you intuitively feel are destructive. But, again, there’s no proof of this to date. Analogy: I claim innovation can be taught, that you can endogenously change the rate inventions are made by teaching kids how to invent (e.g., from hamburger flipper to rocket scientist) by reforming patent laws and, inter alia, offering prizes directly to inventors (rather than their employers as now). But, there’s no evidence this will work (nor is there evidence BTW that the existing patent system is bad, keep this in mind next time Sumner or Alex Tabbarok rail vs patents). It’s just a ‘gut feeling’, like yours.

  32. Gravatar of Ray Lopez Ray Lopez
    5. March 2016 at 07:11

    @Michael 5. March 2016 at 02:27 – your answer to Jerry does not really address his concerns (see my answer above). Keep in mind even our host agrees that money is neutral long term. Given that China has had trade surpluses with the USA for twenty years plus, how does your answer comport with the long term view that money is neutral? At best (and BTW I believe money is neutral even short term) your answer goes to short term effects. “Sterilization” and other such nonsense terms are thrown about by monetarists as if they have long-term significance, which they do not. Put another way (as Tyler Cowen has hinted): the Fed not doing what Sumner wanted back in 2008 arguably made things worse back then, and made a routine recession into a depression (arguably). But it’s almost a decade later, and we’re no longer in the short term, and in fact we’re back to trend, unless you want to argue metaphysics like “hysteresis” and “path dependence” and nonsense like “the long run is a series of short runs”. Do you really thing today’s performance by the US economy is influenced by something the Fed failed to do in a few months of 2008? That you can somehow ***go above trend*** (!) and make up for any output gap lost in the recession if somehow you do something magical with the money supply now? You’re as batty as our host if so. If the US economy is back to trend (as it is now), by definition things are as good as they get. Playing with the money supply won’t get Baby Boomers to un-retire (i.e., won’t change long term real structural effects). But, if you religion tells you the earth was created in 4004 BC, as Bishop Ussher found, then who am I to disagree? Believe what you wish, it’s your religion.

  33. Gravatar of SG SG
    5. March 2016 at 09:16

    Scott, can you explain your position as to why protectionism could cause a recession? are you treating the rise in tariffs as akin to a supply shock, which would boost prices, which would cause the fed to tighten and lower NGDP?

  34. Gravatar of ssumner ssumner
    5. March 2016 at 09:50

    Jerry, It’s simple national income accounting:

    C + I + G + (X – M) = C + Sp + T

    Where Sp is private saving, T – G is government saving and M – X is foreign saving.

    I = Sp + (T – G) + (M – X)

    Ben, Japan is booming? How about Australia? In any case, protectionism reduces exports—so if you want to be export oriented then you don’t want to be protectionist.

    Patrick, Words of wisdom from The Donald.

    Doug, Why should you care whether your house was bought by a Chinese or an American? I wouldn’t.

    dtoh, You said:

    “Not to make an obvious point, but the problem is not the aggregate impact. It’s the impact on individual firms and workers.”

    Too late, you just made it. Seriously, check out my recent Econlog posts on China trade.

    Steve, I have written opposing Ex-IM bank, and for loosening IP laws to reduce Zuckerberg’s wealth.

    Christian, I just did a post a week ago on that paper, which was the longest post I’ve done in months. Check it out.

    SG, Yes, if the central bank is an inflation targeter, it could cause a recession. Also if the Fed targets interest rates.

  35. Gravatar of wiretap wiretap
    5. March 2016 at 10:54

    The trade deficit peaked at close to 5% of GDP, then GDP peaked and fell, and as this blog has noted time and again GDP fell below trend permanently. I’m not sure that %GDP is the right basis for measuring the impact of the trade deficit. As you say a larger deficit does not reduce GDP, but a shrinking deficit could.

    A larger deficit could then be a sign that poor economic performance is imminent. Is trade the cause? Maybe not, but capital flows behind it could be instead.

  36. Gravatar of Jerry Brown Jerry Brown
    5. March 2016 at 11:05

    Thank you Professor! Even on my best days I am bad at algebra if that is what it is called. So I=S. And S can be broken down to foreign saving (M-X), government saving (T-G), and private saving (Sp). So I= Sp + (T-G) + (M-X). But a change in M-X is not necessarily associated with a change in investment (I) unless the other variables are held constant. So it may not be fair to say that an increase in a trade deficit (M-X) implies an increase in Investment. It could just indicate a decrease in private savings. Or an increase in the government deficit. And if neither of those variables changed, it doesn’t say anything about how the composition of Investment might change to match the increasing deficit. I mean that Investment might rise because inventories rose, and that is usually not an optimistic indication.

    But thank you again for responding. I was trying to figure this out all night last night and it was painful. Please correct any errors I am making here. Simple national accounting is not very simple for me.

  37. Gravatar of Matt Waters Matt Waters
    5. March 2016 at 13:10

    “A larger deficit could then be a sign that poor economic performance is imminent. Is trade the cause? Maybe not, but capital flows behind it could be instead.”

    In textbook economics, it should be the other way. Trade deficit has to be offset by investment, or capital surplus. A capital surplus says “this country’s capital has a better chance to produce than my own country’s capital.” This explains how countries like Australia and the US can run a trade deficit for decades.

    I’m afraid of sparking Sumner’s wrath with mention of bubbles and malinvestment. But countries like Greece also ran a heavy trade deficit and capital surplus. In that case, Greece actively hid the true size of their foreign liabilities. So Greece’s malinvestment can still be compatible with the EMH, considering EMH is about PUBLICLY known information.

    But there is malinvestment even in America with decent information (late’90’s Tech bubble and subprime mortgages). I think manias can and do happen. All malinvestment, not just from foreign capital surpluses, hurts long-term economic growth.

  38. Gravatar of dtoh dtoh
    5. March 2016 at 14:01

    @scott
    I’m not necessarily arguing that the reallocation problem makes the economy worse off in aggregate. But it clearly makes the individual who lost their job at GM and is now working at Burger King worse off. Which is why you have political opposition to free trade.

    (Whether it makes the economy worse off overall I think depends on how you measure marginal utility.)

    The rest of the discussion here is just a failure to understand an accounting identity.

  39. Gravatar of wiretap wiretap
    5. March 2016 at 15:43

    “In textbook economics, it should be the other way. Trade deficit has to be offset by investment, or capital surplus. A capital surplus says “this country’s capital has a better chance to produce than my own country’s capital.” This explains how countries like Australia and the US can run a trade deficit for decades.”

    If capital markets were on both sides of the flows that would likely be true. But during the 2000s central banks received much more of the flows, particularly EM CBs. Since many of those EMs were growing faster than the US the textbook motivation is difficult to reconcile with what happened.

  40. Gravatar of Matt Waters Matt Waters
    5. March 2016 at 16:22

    “If capital markets were on both sides of the flows that would likely be true. But during the 2000s central banks received much more of the flows, particularly EM CBs. Since many of those EMs were growing faster than the US the textbook motivation is difficult to reconcile with what happened.”

    I think EM’s chronically invest too much domestically, especially China with their state banks. Plus there are controls against foreign investment in EM’s. So there isn’t international capital flows into China like you would expect.

    China’s currency devaluation has been emphasized too much, IMO. My understanding of China’s policy is their CB pushed exports more by overinvesting in American investments, especially Treasuries.

  41. Gravatar of wiretap wiretap
    5. March 2016 at 18:37

    “I think EM’s chronically invest too much domestically, especially China with their state banks. Plus there are controls against foreign investment in EM’s. So there isn’t international capital flows into China like you would expect.”

    WRT the USA, capital was flowing out of China (and many other places) into the US. Maybe for some of those places those flows came from markets making sensible investments. But I don’t see why there would be any connection between reserve accumulation by CBs and expectations of return on capital.

    Too bad for them, too. If the PBOC had bought longer-term treasuries before the crisis, they would have made out like bandits.

  42. Gravatar of Postkey Postkey
    6. March 2016 at 01:04

    GDP ≡ C + I + G + (X-M) ex post.

    ex ante, GDP = C + I + G + (X-M) when the ‘real sector’ is in equilibrium.

    Start at an initial equilibrium when X = M.

    There is then a fall in X.

  43. Gravatar of ssumner ssumner
    6. March 2016 at 06:44

    Jerry, You said:

    “It could just indicate a decrease in private savings.”

    Which means more consumption. My point is that the GDP equation tells us nothing about the impact of trade deficits on the economy.

    Matt, Of course Greece’s big problem was it’s massive budget deficit, combined with its decision to join the euro.

    dtoh, You said:

    “I’m not necessarily arguing that the reallocation problem makes the economy worse off in aggregate. But it clearly makes the individual who lost their job at GM and is now working at Burger King worse off. Which is why you have political opposition to free trade.”

    True, but that has no bearing on this post. I suggest reading my recent posts at Econlog, which address the issue you are discussing.

    wiretap I think we are now seeing why the Chinese wanted to accumulate a $3 trillion war chest.

    Postkey, Not sure what your point is.

  44. Gravatar of Steve Steve
    7. March 2016 at 19:32

    Professor Sumner,
    shouldn’t the impact of a trade deficit or broader current account deficit on GDP depend on the mechanism by which the savings/investment equilibrium is rebalanced? For example, if the excess of investment over savings is just due to inventory accummulation, this ultimately should be bad for GDP as increased stockpiles will lead to unemployment. What this would represent is a situation where the country in question lacks the credit impulse to consume both its own and foreign production. Whereas if the excess of investment over savings is driven by a consumption-fuelled fall in national savings or a boom in productive investment, this should be a positive.

  45. Gravatar of ssumner ssumner
    8. March 2016 at 13:01

    Steve, Obviously CA deficits that have been going on for decades are not due to unwanted inventory accumulation.

  46. Gravatar of Floccina Floccina
    8. March 2016 at 14:03

    @Matt Waters I would think that the imposition of a 35% tariff would be disruptive, resulting in employees being laid off in some industries faster than they are hired in others.

Leave a Reply