(This item originally appeared at Forbes.com on July 9, 2018.)
Trade issues have again come to the forefront, and with them all the same old arguments that haven’t changed much over the decades. I want to take up the topic of trade, and trade-related issues, without treading the same old ruts that are not very productive today.
Not to be too coy about it, I am mostly on the free-trade side, but I think that the “economic nationalists” have some valid points that should be discussed. However, these valid points typically come wrapped in a series of tired old fallacies, which the free-trader types justifiably dismiss.
One valid point, as I see it, is related to foreign competition, particularly competition from the world’s low-wage countries. Nobody seems to be terribly concerned about competition with developed Europe or Canada. Another valid point is the issue of floating currencies, which introduce arbitrary winners and losers. There are related issues regarding immigration and domestic investment and capital creation. The free-trader types mostly ignore all of these issues, instead repeating a series of learned nostrums in response to every situation. Even if we decide that free trade is a better solution, we should make that decision based on some investigation, rather than asserting that it must always be the best solution in every circumstance, because … it just is.
First of all: the “trade deficit.” This is more properly expanded to the current-account deficit, which includes both goods and services, and also net investment income. Commonly, a current-account surplus is perceived as “good,” and a current-account deficit is “bad.” This implies that countries are in an eternal war with each other – no country can run a “good” surplus unless another runs a “bad” deficit, by definition. But isn’t trade supposed to be mutually-beneficial cooperation? In other words – everyone’s a winner? Since all trade is undertaken voluntarily – each party in the transaction perceives itself to be better off – it would seem that trade must be mutually beneficial.
This is easier to see if you remember that all trade is balanced, by definition. That’s what “trade” is – an exchange of one thing for another. There are no “trade imbalances.” How could there be? Is someone going to give something and get nothing in return? This does happen, in the form of “transfers,” or gifts. These can actually be quite substantial, in the form of official foreign aid, nonprofit contributions, or remittances from overseas family members. But, these are placed in a separate category.
What we call a “trade imbalance” today is actually a process by which one party in the trade accepts – instead of goods and services – some form of asset, typically a financial asset. For example, if you “trade” your employment labor at work for $1000, and then you put that $1000 in a bank savings account rather than spending it, then you have a “trade imbalance” with the Rest Of The World. You “exported” your services, but did not “import” any goods or services. Instead, you acquired a financial asset; namely, a bank account. You could then use that bank account to purchase a stock or bond, or make a private investment, or something of that sort.
Did you “win” this trade? Did the ROW “lose”? You did “win” in the sense that you became wealthier – you now have an asset. However, the ROW gained the benefit of your labor, and the investment of your savings. Since the ROW requires capital (savings) to finance new investment, the ROW benefits too.
Thus, a “trade deficit” or “current account deficit” amounts to investment or savings; that is, a capital flow. When the U.S. runs a current-account deficit, capital (savings) flows from the ROW to the U.S. That is why the U.S.’s current-account deficit is related to domestic economic conditions. When business is good, there are more and more attractive business investment opportunities in the U.S. – often more than domestic capital creation can finance. Thus, more and more foreign capital flows to the U.S. to finance these opportunities. The U.S. ran a current-account deficit for much of the nineteenth century, because the U.S. had such wonderful investment opportunities – Low Taxes, Stable Money, the Rule of Law, political stability, and nearly a whole empty continent to work with. When business is bad, there are fewer opportunities, and less capital is imported.
Commonly, trade statistics reflect genuine issues that are not necessarily related to trade. It should be obvious that if the U.S. runs a consistent current-account deficit – that is, it imports capital – then it is because domestic capital creation (savings) is insufficient to finance domestic business opportunities. This is bad for a number of reasons. One is that more domestic capital typically means more domestic investment, which means more and better-paid jobs. Another is that households would generally be better off if they had more savings and thus, more assets. A third is that, since they financed U.S. investment, foreigners thus become the beneficiaries of their U.S. investments, rather than Americans.
There are two aspects to creating savings: the first is savings itself. Mostly, this is household savings. Individual corporations can save, but corporations as a whole are typically capital-users rather than capital-creators. The second is: consumption of savings (capital) for non-investment purposes. When savings/capital is put into a productive investment, the society is better off. Some new productive asset or enterprise has been created. The investment goes into a hotel, or biotech research, or the marketing of a new cosmetic line, in all cases increasing the productive capacity of the economy and creating jobs. However, if the savings/capital is put into a consumptive use, then it has basically been extinguished. Net savings declines. For households, this is netted out: when one household saves $1000, but another household borrows $1000 for consumption, then the net savings is zero. Nothing is left to finance business opportunities. When the government runs a deficit and sells government bonds, this capital is typically extinguished in consumption. Sometimes, a government can make a productive long-term investment, in a road or port for example. But, most government spending produces nothing of lasting value, and amounts to a form of consumption. We also have various forms of wealth taxes, including double-taxation of business income in the form of capital gains taxes, taxes on dividend income, and also estate taxes, which gradually erode past savings and investment and thus – on top of all their deleterious effects in terms of incentives – amount to a “negative savings.”
We see that we have several genuinely negative patterns happening here: low household savings, possibly an elevated rate of household borrowing for consumption, and government consumption of capital to finance deficits. All of this creates a relative shortage of domestic capital, which then prompts foreign investment, which in turn creates a trade deficit.
So, the perception that a trade deficit is “bad” and a trade surplus is “good” has a lot of real-world justification. A lot of “bad” things can be reflected in a trade deficit, and “good” things reflected in a trade surplus.