Do We Really Want a Narrower Trade Deficit? (the Economy)

Article excerpt

THE WIDE TRADE DEFICIT OF the last few years has led to increased concerns about its implications for the economy. The trade deficit has largely reflected relative strength (we can afford more imported goods). There is nothing inherently wrong with running a large trade deficit (say 4% or so of GDP). However, as was the case a few years ago, an ever-widening trade deficit is not sustainable. There is an important connection between the trade deficit, the budget deficit, and the shortfall in private-sector savings (gross investment less household and business saving). Economists are aware of this connection, but the public generally is not.

It is relatively simple to show that the trade balance (imports minus exports), the budget deficit (tax receipts less government spending), and the private-sector investment-savings shortfall (gross investment less business and household savings) sum to zero in equilibrium. One of these balances cannot be changed without affecting the other two. The equilibrating mechanism is the dollar. When we import foreign goods we effectively send our dollars overseas. What happens to those dollars? They come back in the form of foreign purchases of U.S. goods and services or, as we've seen in the last several years, through the purchase of U.S. financial assets. Trade outflows have been more than offset by capital inflows in recent years, which has kept the dollar strong.

When we run a trade deficit, we effectively borrow foreign savings at the same time. As with borrowing money from a bank, the key issues are the debt service burden and whether the lender will remain willing to roll over existing debt. Over the latter part of the 1990s, the U.S. economy experienced a very strong pace of investment. Much of that investment was fueled by capital inflows. The expansion of the capital stock helped boost productivity, making it easier to service foreign debt. …

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