A Convenient Truth:

The Real Story behind

Americas Trade Deficit
Daniel Griswold
Cato Hill Briefing
March 21, 2007
America's Growing Globalization, 1900-2006
30%
Exports and income receipts Imports and income payments
25%

?
20%
World War I
15%
World War II
10%

5%
Great Depression
0%
1900 1915 1930 1945 1960 1975 1990 2005
Sources: Historical Statistics of the United States, Economic Report of the President 2007, and Bureau of Economic
Analysis.
Why We Trade with Foreigners
Adam Smithdivision of labor
Ricardocomparative advantage
Exportseconomies of scale
Import competitionlower prices,
choice, quality
Producers as importerssteel and sugar
Competition promotes innovation and
growth
The truth about trade
Mercantilist mindset: Exports
good, imports bad.
Who gains most from farm trade
reform? The reformers!
OECD farm trade liberalization:
OECD countries gain $92 billion,
poor countries $10 billion (IMF).
What about Global Imbalances
that is, the big, bad trade deficit?
No aspect of international trade
is so widely discussed and yet so
little understood as the trade
deficit.
To mercantilists, a trade deficit is
by definition a sign of failure
Let me explain it to you one more time, Lou.
The Trade Deficit that Ate America
''The consequences of these
persistent and massive trade
deficits include not only failed
businesses, displaced workers,
lower real wages and rising
inequality, but also permanent
House Speaker
devastation of our
Nancy Pelosi communities.'
-- Democratic congressional leaders,
February 13, 2007, letter to Bush
Americas trade balances, 2006
Merchandise balance (goods) -$836.0 b
+ services +$70.7 b
Equals
Trade balance (goods and services) -$765.3 b
+ investment income -$7.3 b
+ unilateral transfers -$84.1 b
Equals
Current account balance -$856.7 b
Balancing our International Books
Current Account Financial Account

Trade in Goods and Trade in Assets

Services
A Bit of Trade Deficit Algebra
Y (GDP) = C + G + I + (Ex-Im)
Y - C - G - I = Ex-Im
(Y-C-T) + (T-G) - I = Ex-Im
S(p) + S(g) - I = Ex-Im
S - I = Ex-Im
Net exports = Savings - Investment
Implications for U.S. policy
Trade deficits are immune to trade
policy.
Changing the trade deficit requires
changing the savings and
investment balance.
Trade deficits tend to be
pro-cyclical. (S I = Net Exports)
Are Trade Deficits A Drag on U.S. GDP Growth?

Change in Real GDP (1980-2005)

when CA Deficit:
Shrinks as share of GDP 1.9%
(improves)
Grows modestly as share of GDP 3.0%
(worsens by 0.0 to 0.5% of GDP)
Grows rapidly as share of GDP 4.1%
(worsens by > 0.5% of GDP)
 Who is "De-Industrializing"?
Industrial Production 1990-2006 (1990 = 100)
180
"Country A"
160

140

"Country G"
120

100

"Country J"
80
1990 1992 1994 1996 1998 2000 2002 2004 2006
Source: Economic Report of the President 2006 ; Joint Economic Committee
U.S. Manufacturing Output, 1980-2006
(Monthly index, 2002 = 100)
120
2.6 % annual growth 3.6 % annual growth
110
100
90
NAFTA
80
China Fixes Yuan
70
Uruguay Round/WTO
60
50
40
1980 1985 1990 1995 2000 2005
Source: Federal Reserve Board
 U.S. Manufacturing Imports and Output
(19892006)
10%
Change in Manufacturing Output

1997
8% High Import, 1998
1996
1995
6% High Output 1994
2005
4% 2000
2006 1993 1999
2% 1989
1990 1992
0% 2003 2004
2002
-2% Low Import,
1991
-4% 2001 Low Output
-6%
-8% -4% 0% 4% 8% 12% 16%
Change in Real Imports of Manufactured Goods
Sources: Bureau of Economic Analysis; Federal Reserve Board.
A word about trade and jobs
Trade is not about more or fewer jobs, but
about better jobstrading up.
Trade displaces workersabout 400k/year.
Compare to 140 million in workforce, 300k
unemployed each week, 15 million jobs
eliminated each year.
Trade accounts for < 3% of job churn.
Internal competition, changing consumer
demands, new technology more important.
Is the trade deficit sustainable?
Net international investment position
America a debtor nation since mid-
1980snow $2.5 trillion.
Foreigners own $13.6 trillion in U.S.
assets, Americans own $11.1 trillion in
assets abroad at end of 2005.
Foreign debt 20 percent of GDP,
< 5 percent of national wealth.
Is the trade deficit sustainable?
In 2006, Americans earned $622 billion
on investments abroad, paid $629
billion on foreign investments in U.S.
U.S. paid net -$7 billion on income.
Benefits of foreign capital:
less crowding out from fiscal deficit
lower domestic interest rates
mortgage savings = $1,500/year
Americas economic sovereignty
Foreigners own 1/4 of outstanding $8 b
federal debt, private U.S. citizens 1/4,
government itself owns 1/2,
Chinese own $350 billion, <5% of U.S.
debt
Gives foreigners stake in U.S. prosperity
Exercise of U.S. sovereignty to engage
in global economy, realize its benefits
For more information
www.freetrade.org
dgriswold@cato.org
202-789-5260