What to Do about the Trade Deficit: Nothing

Roosevelt Institute has a new roundup of policy advice for the next administration. There is a lot of useful stuff in there, which perhaps I’ll post more on later. My own contribution is on international trade. Here’s the summary:

It is natural to look to measures to improve the trade balance — through a weaker dollar, or through tariffs or other direct limits on imports — as a way to raise demand and boost output and employment. While the U.S. has done little to boost net exports in recent decades, there is increasing public discussion of such measures today…

We argue that while the orthodox view is wrong about trade being macroeconomically neutral, measures to improve the U.S. trade balance would nonetheless be a mistake. All else equal, a more favorable trade balance will raise demand and boost employment. But all else
is not equal, thanks to the special role of the U.S. in the world economy. The global economy today operates on what is effectively a dollar standard: The U.S. dollar serves as the international currency, the way gold did under under the gold standard. In part for this reason, the U.S. can finance trade deficits indefinitely while most other countries cannot. For many of our trade partners, any reduction of net exports would imply unsustainable trade deficits. So policies intended to improve the U.S. trade balance are likely to instead lead to lower growth elsewhere, imposing large costs on the rest of the world with little or no benefits here.

We do not deny that the trade deficit has negative effects on demand and employment in the U.S., but we argue this is only a reason to redouble efforts to boost domestic demand. The solution to the contractionary effects of the trade deficit is not a costly, and probably futile, effort to move toward a trade surplus, but rather measures to boost investment in both the public and private sector.

You can read the rest of my piece here.

There were a couple figures that didn’t make it into the final piece. Here is one, showing the stability of the international role of the dollar over the past 20 years.


The dotted line shows the share of central bank reserves held in dollars (source). The heavy line shows the share of foreign-exchange transactions that involve the dollar (source). About two-thirds of foreign exchange reserves are held in dollars, and close to 90 percent of foreign-exchange transactions involve the dollar and some other currency. These shares have not diminished at all over the past 20 years, despite continuous US trade deficits.

In my opinion, the international role of the dollar makes it exceedingly unlikely that the US could face a sudden outflow of foreign investment. (And given that US liabilities are overwhelmingly dollar-denominated, it is not clear what the costs of such an outflow would be.) It also makes it highly unlikely that the US can achieve balanced trade through conventional measures, unless we come up with some other mechanism to provide the rest of the world with dollar liquidity.

6 thoughts on “What to Do about the Trade Deficit: Nothing”

  1. I understand your reasoning that tariffs or protectionism would not be the cure all that people think as well as the effect of the dollar standard. That being said I think we still need to have companies that “make things” where young people can learn a craft. A while back I read Factory Man by Beth Macy about the decline of the furniture industry in the US. That is the dark side of globalization. Hundreds of people lost generations of jobs. And while I agree that trade has positives, too much cheap crap has been made in China such as furniture when young people here need to learn to make things. I think trade has huge environmental costs as well. In the Jackie Robinson documentary they talk about how everything you need to live you could buy within two blocks back then.

  2. Also like many economists you seem to use very unempathetic, detached language in your views of trade. “We do not deny that the trade deficit has negative effects on demand and employment in the U.S.” Negative Effect?? Have you read the stories of severe homelessness in cities? The destruction of cities and communities when companies leave like Carrier recently. “are likely to instead lead to lower growth elsewhere”. Who cares about lower growth elsewhere??? When no one is our country is living in poverty then we can talk about growth elsewhere. On a deeply emotional and empathetic level try to understand the effects of globalization on families and communities IN THE USA and then let me know if you feel the same way about trade. And how do you explain the increasing globalization of service jobs??? Does that fit with your dollar liquidity model?? Please read Factory Man and then maybe you will get it. Thanks

    1. The tone of a piece depends on where it’s written for. Trying to use my Roosevelt platform to make impassioned speeches might make me feel good while I was typing them, but it wouldn’t serve any other purpose — they wouldn’t get published, and wouldn’t be read by the people I want to reach if they were.

      Who cares about lower growth elsewhere??? When no one is our country is living in poverty then we can talk about growth elsewhere.

      I don’t share this point of view.

  3. Lastly Bretton Woods was started in 1944 after WWII. We had two decades of prosperity until the 70’s. We had the dollar standard in the 50’s and 60 “s when our economy was good and many had good jobs. So your dollar standard argument in trade deficit does not apply before the 70’s. So what changed to exponentially increase the trade deficit?? Nixon not pegging the dollar to gold in 1971? China joining the WTO? It seems your dollar standard argument only explains part of the story.

  4. I agree with your points, although on the long run I think that the rest of the world should become less dependent on “stimulus trickle down” from the USA.
    However I think that there is another problem that somehow is never explained, which is:

    How – through what policies – does the USA become a net exporter (or at least reduces its net imports)?

    The USA government cannot just wave a magic wand and make this happen; I think that there are 3 options, and all 3 have big limits.

    option 1) Internal devaluation/austerity.
    This is the option currently implemented by the EU, the idea is to have a big crisis so unemplyment rises, wages fall, and at some point the country will became a net exporter.
    This sucks for the workers, increases unemployment instead of decreasing it, and creates deflationary crises to booth – not a good idea.

    option 2) Devalue the dollar.
    Okay, but what actions should the USA government adopt, that it isn’t already adopting, to devalue the dollar?
    And also, if the dollar falls in value, but american wages rise, it’s a wash, so the government should still implement some sort of austerity while devaluing the dollar.
    This still sucks, though not as much as option 1.

    As a side note, China did reap big advantages by becoming a net exporters, and Chinese wages rised a lot in absolute terms. But this happened with Chinese wage share falling, and Chinese productivity rising due to technologic catch-up.
    The USA would not have the technologic catch-up, so no rise in productivity, so the fall in the wage share would not be counterbalanced by anything, a net loss for USA workers.
    For this reason, USA workers cannot follow the “Chinese strategy” (which is the good old “infant capitalism” strategy).

    option 3) tariffs on imports
    This looks less bad than the previous options, but I don’t think that it is as easy as it seems: the USA would mostly repatriate jobs that, by now, are “low added value” ones (because of international competition), and still would need to import a lot of energy.
    If trade partners retaliate with other tariffs (assuming that the tariffs are big enough to have a significative effect on trade) then the USA would still end up as a net importer, until it manages to lower import to almost 0 (and for energy I don’t think that this is posssible).
    This however depends mostly on the actions of the trade partners, so it depends on how much the government of the USA can coerce other governments to operate as net importers. In my opinion it can’t, but I might be wrong.

    So in the end I suspect that the USA is not able (presently) to become a net exporter, unless it manages to enter in a very big crisis.

    1. I agree with all this. Besides the arguments in the Roosevelt piece, it’s not clear how policy would deliver a more favorable trade balance in practice. (Except by slower GDP growth, which definitely would work.) I may write a longer version of the piece, in which case I’ll make this argument as well.

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