Untangling the Trade Deficit
Taylor, Timothy, The Public Interest
The competition for most misunderstood economic statistic is hard-fought, but there is a clear winner: the trade deficit. No other number is interpreted so differently by professional economists and the general public. Common reactions to the U.S. trade deficit range from belligerence to dejectedness: It is thought that America's trade deficit exists either because of the skullduggery and unfair trade practices of countries that shut out U.S. products, or because American companies are failing to compete against their global competitors. In either case, the preferred solution is often to get tough in trade negotiations for the sake of protecting U.S. jobs. But, according to most economists, cutting across partisan and ideological lines, such mainstream beliefs about cause, effect, and solution are wrong. Even more bothersome, these popular beliefs are wrong not simply because the evidence is against them - although it is - but because they reflect fundamental misunderstandings of what the trade deficit is and how it interacts with the rest of the economy.
America's economic illiteracy on this subject may come to matter a great deal. The U.S. trade deficit has been on the rise, from $56 billion in 1992 to $155 billion in 1997. But the recent economic troubles in East Asia are prompting predictions that producers in those countries will flood U.S. markets with imports while reducing their purchases of U.S. exports, which will increase the 1998 trade deficit by $50 billion or more. In political terms, America's rising trade deficit will aid and abet the anti-free-trade forces, which run the gamut from Richard Gephardt on the left to Patrick Buchanan on the right, along with Ross Perot in some dimension all his own. There will be increased pressure for cutting back on U.S. imports from other countries, resistance to giving the president fast-track approval to negotiate trade agreements without fear they will be picked apart in Congress, and opposition to future free-trade agreements.
Along with most economists, I believe that the attempt to reduce global trade is both impractical and unproductive. But it would be especially foolish, verging on surreal, if America were to make the mistake of turning its back on free trade in part because of a lack of basic economic literacy about what a trade deficit is and what it means.
Components of the trade deficit
Part of the confusion about the trade deficit arises because the U.S. Department of Commerce reports several versions of the trade deficit, and the differences among them can be tens of billions of dollars. In mid February 1998, for example, the New York Times ran a story discussing a 1997 "trade deficit" of $191 billion. About a week later, I saw an Associated Press release discussing the 1997 trade deficit of $114 billion. Even as I read these articles, I knew that the Department of Commerce would not release its preliminary version of what most economists consider the most definitive measure of the 1997 trade deficit until mid March 1998; after being revised slightly in mid June, this measure of the trade deficit came in at $155 billion. None of these trade-deficit numbers are wrong; they are just defined differently. But, for the casual reader, the parade of different numbers must create some confusion.
The biggest trade-deficit number, which was revised in June 1998 from $191 billion to $198 billion for 1997, is calculated by taking America's exports of goods and subtracting America's imports of goods. The fact that it is a deficit, rather than a surplus, means that imports of goods are $198 billion larger than exports.
But, in the modern economy, it is surely too limiting to consider goods only. In 1997, just 36 percent of the U.S. gross domestic product (GDP) was goods while 55 percent was services. (The rest is structures and changes in inventories.) Some services are obviously difficult to trade internationally: It's not clear how one ships housecleaning or haircutting services overseas. …