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U.S. Month at a Glance

Latest issue:
December 11, 2017

Kip’s Commentaries

Read the latest commentaries by Kip Beckman, Principal Economist, World Outlook

Inadequate Savings—Not Trade Deals—Account for Much of U.S. Trade Deficit

Apr 28, 2017
Kip Beckman
Principal Economist
World Outlook

In the 1930s, the U.S. ran trade surpluses for almost the entire decade. Had Donald Trump been president at the time, this statistic would, presumably, have made him happy.

However, the trade surpluses in the 1930s were directly linked to the Great Depression, which had such a devastating effect on the U.S. and world economies that American households stopped buying imports. This historical fact highlights how a trade surplus isn’t necessarily a sign of a healthy economy. Nor does a trade deficit imply that an economy is on the verge of ruin.

Yet, during the election campaign, Trump railed against the large trade deficits that the U.S. has with countries such as Mexico and China. He reportedly complained to his staff that he couldn’t find one country that the U.S. ran a trade surplus with.

Trump contends that trade deficits are a result of unfair trade policies. In his version of events, countries with large trade surpluses with the U.S. put high tariffs on imports of U.S.-made goods and services, making U.S. exports uncompetitive in these foreign markets. At the same time, Trump says, the U.S. doesn’t impose the same trade restrictions. Consequently, cheap imports flow into the country and lead to large trade imbalances. U.S. companies can’t compete with these low-cost imports flooding the U.S. market and are forced to lay off workers.

Some U.S. trade partners, including China and Japan, have implemented tariff and non-tariff barriers on U.S. exports that make it difficult for U.S.-made products to penetrate these markets. But the U.S. itself is not exactly a beacon of free trade. For example, it protects different segments of its agriculture sector, among others, against foreign competition.

In contrast to Trump’s view, a more plausible explanation for the chronic trade deficits that the U.S. has been running since the early 1980s can be found in the trends in savings and investment. In simple terms, the U.S. consumes more than it produces and doesn’t save enough. The lack of savings applies both to households, which have elevated levels of debt, and to the federal government, which continues to run large budget deficits. The shortfall in savings is financed by selling U.S. assets, such as government bonds, to foreign buyers. The funds raised from the sales of U.S. assets are used to fund consumption and investment spending. Consequently, the U.S. trade deficit is equal to the flow of foreign capital into the United States.1

The Wall Street Journal’s Greg Ip notes that the links between savings and the trade balance are apparent in the experience of numerous countries. If, as Trump insists, trade deficits were caused by protectionist measures, countries that implement barriers to limit imports should run trade surpluses. However, this is not the case. According to the World Bank, India and Brazil (which are highly protectionist) consistently run large trade deficits because, like the U.S., they save less than they invest. Conversely, Germany and Switzerland have relatively low tariffs and run trade surpluses because they save more than they invest. They lend their excess savings to countries such as Brazil and India to help them fund chronic trade deficits.

Trump also contends that free trade deals such as NAFTA were negotiated unfairly and provide other countries (in the case of NAFTA, Canada and Mexico) with an advantage over the United States. This perception of trade deals was a key factor behind his decision to pull the U.S. out of the Trans Pacific Partnership trade agreement. Just as there is no link between protectionist measures and trade balances, Trump’s claim that there is a connection between trade deals and large U.S. trade deficits is flawed. The U.S. has large trade deficits with Japan and Germany, yet neither of these countries has a trade agreement with the United States.       

In the past, the U.S. government tried to reduce trade deficits by insisting that major trading partners adjust their trade policies. In the 1980s, the Japanese government agreed to voluntarily restrain exports of cars to the U.S. market to address the large trade imbalance between the two countries. This agreement eventually led Japan to shift some of its car production to the U.S. to quell the anger in the U.S. Congress. However, these initiatives failed to arrest the growth in the trade deficit because the U.S. continued to save less than it consumed.

Japan’s experience provides evidence that higher savings can lower trade imbalances. Post-war Japan was a high-savings country and ran large trade surpluses. But these surpluses have started to gradually diminish as aging Japanese workers retire and spend their savings on goods and services, including imported ones. This could eventually happen in the U.S., but not for a while. The U.S. savings rate was generally above 10 per cent until the mid-1980s, but the rate has gradually declined since then and currently sits at between 5 and 6 per cent.

Ironically, by threatening to punish Mexico for its large trade surplus with the U.S., Donald Trump is picking a fight with a country that has a similar problem. Mexico has a healthy trade surplus with the U.S., but runs an overall deficit when its trade with other countries is included in the total. And Mexico has a trade deficit for the same reason as the U.S.—it doesn’t save enough and must borrow from abroad to make up the difference.

Sources

Greg Ip, “Deficits Are a Flawed Guide to Unfair Trade Practices,” The Wall Street Journal (March 15, 2017); Alan Reynolds, “What the China Trade Warriors Get Wrong,” The Wall Street Journal (October 26, 2016).


Related Report

U.S. Outlook Spring 2017

Related Webinars

NAFTA 2.0 and Canada
The Conference Board of Canada, June 13, 2017 at 02:00 PM EDT
Live Webinar by Kristelle Audet, and Danielle Goldfarb

Canadian Outlook with the Chief Economist: Economic Growth Accelerates But Risks Abound
The Conference Board of Canada, June 21, 2017 at 02:00 PM EDT
Live Webinar by Craig Alexander

1    Trade in financial assets are included in the capital account of the balance of payments. The U.S. current account deficit on trade in goods and services is matched by a capital account surplus as capital flows into the U.S. to finance the current account deficit.


International Economics Team

Kip Beckman

Kip Beckman
Principal Economist