Part 2. How to afford a shopping spree

No single factor created america’s trade imbalance

 

President Trump’s trade policy is based on one core idea: America is disadvantaged in the global economy. There are a few common arguments. Other countries manipulate their currencies to keep prices low. They target US firms with discriminatory trade barriers. They even flout the rules and regulations embedded in trade deals.

Under these conditions, America’s firms find it difficult to compete. Hence, a trade deficit. 

Is Trump right about the challenges facing US firms? What are the principle sources of America’s imbalance? 

Numerous factors contribute to the deficit, including the value of the US dollar, fundamental shifts in global production, and international trade law. 

 

Currency values

The relative value of a country’s currency — that is, the exchange rate — is an important determinant of trade flows. All else equal, countries with more valuable currencies enjoy greater purchasing power. To see why, think about traveling to a foreign country. Money goes further when visiting countries with relatively less valuable currencies.

It works the same way in trade. Having a more valuable currency means an economy can consume more foreign goods.

But there’s an obvious trade-off. Countries with more valuable currencies find it harder to sell goods abroad. Those goods are more expensive because foreign buyers have less purchasing power.

 
 

This has an implication for America’s trade deficit. The US dollar is one the ten strongest currencies in the world. This means firms and households that hold dollars can afford to buy of the stuff made where currencies are weaker. One of those places is China.

When President Trump complains about China’s currency manipulation, it’s precisely because Beijing keeps China’s currency lower than the dollar. This keeps the price of Chinese exports down, ultimately contributing to America’s deficit. Stores can stock their shelves with Chinese goods in part because the Yuan is cheaper than the dollar.

 

Shifts in Global Production

We commonly hear phrases like “the US doesn’t produce anything anymore” when politicians bemoan the decline of American manufacturing. We will discuss the health of the manufacturing sector later in this series. For now, it is simply important to recognize that the US has transitioned to a technology- and service-based economy.

It’s worth pointing out an often-neglected fact. While fewer services are traded, the US runs a high surplus in services trade. Regardless, the services surplus is swamped by the large deficit in goods.

Why has there been a shift?

In part, US manufacturing is a victim of the economy’s broader success over previous decades. For many years, rising labor costs in America mean that lower-skilled, labor-intensive production is done more efficiently elsewhere. Hence, the outsourcing of jobs and the erosion of the manufacturing base.

Whatever the underlying cause, the fact is that production has globalized to the extent that the US — and much of the OECD — has lost a comparative advantage in manufacturing. 

 

Trade Agreements

More controversially, there is growing concern that America’s trade deficit is an artifact of international trade law. The short version of the argument is this: trade agreements infringe on US sovereignty. They handcuff the US government, making it impossible to protect domestic interests. All the while, other countries freely violate the rules.

There is relatively little evidence to support this logic. The United States deploys a wide variety of trade barriers to protect the interests of its domestic producers. It’s difficult to say that trade agreements have tied the US government’s hands.

 
 

Critics respond that the US faces more trade-related litigation than other countries. That is true; it has been sued more often at the WTO than any other country. However, the US also sues its partners more often anyone else. 

Nevertheless, there is widespread concern, particularly in the current White House, that trade deals systematically disadvantage US firms.

 

Summary

These are just three of the reasons why America faces a large deficit. The question remains: is the trade deficit actually a bad thing? We now turn to some of the prominent debates over the deficit. The first post starts with jobs.