New School Politics

What’s so great about a trade surplus?

Ryan | 11 02 2008

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From Walter Williams:

Professor Don Boudreaux, chairman of George Mason University’s Economics Department, wrote “If Trade Surpluses Are So Great, the 1930s Should Have Been a Booming Decade.” According to data he found at the National Bureau of Economic Research’s “Macrohistory Database“, it turns out that the U.S. ran a trade surplus in nine of the 10 years of the Great Depression, with 1936 being the lone exception.

During those 10 years, we had a significant trade surplus, with exports totaling $26.05 billion and imports totaling only $21.13 billion. So what do trade surpluses during a depression and trade deficits during an economic boom prove, considering we’ve had trade deficits for most of our history? Professor Boudreaux says they prove absolutely nothing. Economies are far too complex to draw simplistic causal connections between trade deficits and surpluses and economic welfare and growth.

I think Boudreaux, who writes at Cafe Hayek, is right on the money. It is no surprise that the depression years were the years in which America experienced its most “favorable” balance of trade. After all, if you look at the US trade deficit compared to GDP over time the US trade deficit has tended to grow in times of prosperity (mid/late ’80s, mid/late ’90s, early/mid ’00s) and shrink in times of slowdown (early ’70s, early ’80s, early ’90s).

Nevertheless it’s all too often that we hear politicians demogauging about trade imbalances, especially that with China, whose devalued currency is responsible for delivering even cheaper goods to the market. Policy-wise reducing the trade deficit would require some sort of trade barriers (i.e. tariffs), devaluing our currency (which we are indirectly doing by making money easier), or compelling other nations (like China) to stop devaluing their currencies. Either way, the policy means higher prices and less purchasing power for the American consumer. Moreover, it does not make the US any more productive, and as a matter of fact it makes us less productive by discouraging foreign investment.

But amidst the Fed’s devaluing of our currency and our economic downturn, I would expect the anti-trade polls to be happy because our trade gap has been narrowing in the meantime (at least in the past year since our financial woes began).

Moreover, recently released numbers show that the trade deficit closed in December and in 2007 overall as bad economic news continues to pour in.

Ultimately, as Boudreaux said, the trade deficit doesn’t really matter because as Adam Smith first articulated specialization and comparative advantage and other intricacies govern trade balance. However, based on theory and data, I must take my conclusion one step further to say that a trade deficit is usually indicative of economic strength and growth, rather than an economic problem. I say this because in any economic system you can only consume as much as you produce (Say’s Law) and concurrently a nation can only import if it has the purchasing power to compensate. The more a nation produces the more it can buy, hence the more it imports. Moreover, the greater share of global product it produces, the greater share of global goods and services it will import. This is why American slowdowns have resulted in less imports and a tighter trade gap. And most importantly, upon realizing this, it is imperative that our country does not submit to economic sensationalism, and does not spite itself by instituting protectionist policies which only hamstring American living standards.