Trade Deficits Don’t Matter – Unless Caused by Government

In 2016, the US exported goods and services equal to $2.209 trillion, and imported goods and services with a market value of $2.712 trillion. The balance of trade deficit for 2016, therefore, came to $502.3 billion. The trade deficit represented a little over 10 percent of the over $4.92 trillion of total trade in goods and services between America and the rest of the world. And was only about 2.7 percent of the entire $18.56 trillion Gross Domestic Product of the United States in 2016.

I follow a self-imposed fiscal "austerity" policy in managing my household finances.

But listening to the rhetoric coming from Donald Trump and others in his administration, it would be easy to assume that America’s balance of trade deficit is causing market misery and economic harm to the American people.

Nothing could be further from the truth. The conceptual fog and policy confusion can be cut through if we focus on and start with where all economic activity begins: the individual buyer and seller in the marketplace.

For instance, I am personally running huge balance of trade deficits with many of the private sector individuals with whom I interact in the marketplace. Yet, I do not feel being taken advantage of by those from whom I buy more than I sell.

In addition, I follow a self-imposed fiscal "austerity" policy in managing my household finances. I spend less on current consumption purposes than my income would otherwise allow due to the fact that I use part of my income to pay back previously incurred debt. Plus, I put savings aside (from which I earn interest income and capital appreciation from owned assets), to facilitate others people’s investment and related spending to fund their capital formation activities.

Each of Us is an “Exporter” and “Importer”

"What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom."

In the social system of division of labor, I earn my salaried income from "exporting" my teaching skills and services to an institution of higher learning. Students (or their parents) pay tuition to that institution, from which my salary is paid for classroom and other services rendered.

I most certainly enjoy teaching and having the opportunity to share my understanding of economic theory and its application to a wide variety of social and economic policy issues with those young minds in the classroom. But as I often tell my students, I hope they will not be too offended when I say that if that institution was not paying me, I would likely not be enjoying their company in that classroom.

In other words, I "export" my teaching services to others as the means to my market-based ends -- the "importing" into my household all the goods and services produced by and purchasable from others in a now increasingly global marketplace.

Adam Smith explained long ago in his famous book, The Wealth of Nations (1776), the reason why I and everyone else in modern society does this:

“It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The tailor does not attempt to make his own shoes, but buys them of the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a tailor. The farmer attempts to make neither the one nor the other, but employs those different artificers.

“All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbors, and to purchase with a part of its produce, or what is the same thing, with the price of a part of it, whatever else they have occasion for.

“What is prudence in the conduct of every private family can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better to buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage . . .

“It is certainly not employed to the greatest advantage when it is directed towards an object which it can buy cheaper than it can make it . . . The industry of a country, therefore, is thus turned away from a more, to a less advantageous employment, and the exchangeable value of its annual produce, instead of being increased, according to the intention of the lawgiver, must necessarily be diminished by every such regulation.”

Each of Us Would Live Primitive Lives without Trade

Every one of our individual lives would be lived at a primitive level if we each had to rely on our own productive abilities in a self-sufficient attempt to satisfy all of our individual ends, goals and purposes based on our particular knowledge, skills, and experience, and the geographical accidents of the resources and raw materials fortuitously located in our personal physical proximity.

We can gain from buying things or using the services even of those noticeably less efficient and productive than ourselves.

By participating in a social system of division of labor we all improve our own circumstances by reciprocally bettering that of all those with whom we trade. We each have at our disposal through the competitive market process numerous goods and services that would otherwise not be available to us if we could not draw upon other people's skills and abilities or resources that we lack.

We also benefit because there are others who can make goods or services desired by us in less time or of a better quality than if we undertook their production or provision on our own.

Furthermore, even when we are better at a variety of activities than many of our potential trading partners, we are, no doubt, particularly better at one or a small handful of things compared to others we might devote our time to doing. In this case, trade with others frees us up to specialize at what we are, especially in market value terms, most productive so to maximize the income we can earn on the basis of which we can then buy – “import” – as many of what others have for sale as our income permits.

Thus, we can gain from buying things or using the services even of those noticeably less efficient and productive than ourselves in certain activities so to enable us to specialize in what other potential trading partners value more or most highly for us to do for them.

We all Run Trade “Surpluses” and “Deficits” with Others

It is inescapable that in such a market system of division of labor we will each run trade "surpluses" with some of our trading partners and trade "deficits" with many of the others. There are, alas, few who are interested in "importing" my economics teaching, lecturing and writing services, but there are many who "export" goods and services I wish to buy. Hence, to earn an income I rely on the smaller number in society interested in buying my "exports" to financially cover my purchases of many other "imports."

I run a trade “deficit” with these people, in that I buy more from them than they buy from me.

Thus, I may earn, say, $1,000, from offering an economics lecture to an audience of 50 people, none of whom might be direct or indirect producers of specific goods I’m interested in buying. They “import” more from me in the form of the dollar value of my lecture, than they “export” to me as payment in the form of particular goods they have to sell. I run a trade “surplus” with them, and they have a trade “deficit” with me.

On the other hand, I may spend that $1,000 on the goods or services offered by 5,000 other people who participated in the manufacture and marketing of goods that I do desire to buy, but all of whom would not spend ten cents to hear a boring talk on the economics of international trade. I run a trade “deficit” with these people, in that I buy more from them than they buy from me. So theirs, at the same time, is a trade “surplus” in their market exchanges with me.

Trade Imbalances Reflect Savings and Investment Decisions

Now, my personal overall balance of trade may be either "positive" or "negative." If my "imported" purchases from others are less than my income-generating "exports," then I am a net exporter. That is, I am a net "saver" who lends part of my earned income to others, most usually indirectly through financial institutions who take my deposited savings with that of others and lend it out to presumed credit-worthy borrowers. I anticipate receiving back the principle that I’ve lent plus any agreed-upon interest for foregoing the use of my own “export-earned” income on either other more immediate “imports” of desired goods or more directly using my own savings for some investment purpose.

Little attention is given to the balance of trade of Ohio relative to, say, Nevada or Vermont.

Or, the relationship could be the reverse. I might be the one with an overall balance of trade “deficit.” That is, I wish to undertake an investment that my own income or previously accumulated savings is insufficient to fully fund; so I “import” other people’s financial capital to apply to a (hopefully) profitable enterprise undertaking that will more than pay for the borrowed sum in the future when the investment period has been completed. I plan to offer a product to others on the market from which I project sales revenues great enough to pay back the borrowed funds and interest payments, and still earning a profit that will have made the undertaking seem all worthwhile.

Whether I’m the net exporter of my savings to others or the net importer of others’ savings for my own purposes, in any such willing trade across time of savings lent “today” and its payment back on a future “tomorrow,” both borrower and lender view themselves as better off than if they were denied or prohibited from taking advantage of this discovered exchange opportunity to improve their respective circumstances as they view their options and their time-valuation preferences.

When these financial transactions (and some other categories of items) are combined with the buying and selling of more immediate and specific finished goods and services the balance of trade is transformed into the balance of payments. That is, a summing of all transactions on an overall balance sheet. If all entries have been properly recorded the two sides of this balance of payments balance sheet will equal each other. The monetary sum of savings lent will equal the monetary sum of investments undertaken between individuals in their “exporter” and “importer” roles in the marketplace.

National Trade Balances Come from the Trade of Individuals

Now what is true for you and me, as outlined so far, is no less true if looked at from the perspective of the nation as a whole. Due to the historical tradition of viewing the economic activities of all the citizens of a nation-state summed together as representing a distinct and meaningful political unit of analysis and policy, it is common to speak of the balance of trade of one country relative to other countries with whom its citizens interact.

During a good part of the nineteenth century, the US experienced an overall balance of trade deficit with its trading partners.

We can add up all the individual balances of trade of the people residing in, say, Charleston, South Carolina. These can be summed together with everyone else living and working in the state of South Carolina. And this, in turn, can be summed and added to the balances of trade of all the other people living and working, respectively, in the remaining forty-nine states of the United States of America.

Now, since it is so common to think only of nation-states in relation to each other on the grand stage of global political and economic affairs, little or much less attention is given to the balance of trade of Ohio relative to, say, Nevada or Vermont. But this, too, would show all the same features, in their general characteristics, as looking at the balance of trade of an individual at one end of the analytical spectrum and the balance of trade of the United States vis-a-vis other nations in the world at the other end of that analytical spectrum.

Balance of Trade Deficits Can Feed Economic Development

During a good part of the nineteenth century, the young United States experienced an overall balance of trade deficit with its international trading partners. In other words, the citizens of the United States were net importers of capital to fund and finance investments and other capital projects. In exchange, American business entities traded bonds (promises to pay back the borrowed money at some time in the future) or stocks (offered titles of partial ownership into these enterprises to attract the needed financial capital).

Individuals are the “active” agents; the national trade data is merely a reflection of their economic activity.

It was this foreign capital reflected in annual balance of trade deficits that accelerated America’s emerging industrial revolution in the middle decades of the nineteenth century, an industrial revolution that, otherwise, would have had to be dependent on domestic savings alone. By the second half of the 1870s, the United States began to have balance of trade surpluses, as the citizens of the country exported more to its trading partners than they imported.

There were a variety of reasons for this change, but as the nineteenth century progressed a leading one was that American citizens were paying back the foreign loans that has financed American industrial development. In the years immediately before the start of the First World War in 1914, American citizens began to become net exporters of financial capital to other nations around the world. The United States became a creditor rather than a debtor nation.

But whatever the national trade statistics may have shown for the country as a whole in the nineteenth and early twentieth centuries, the fact was that the nation-wide statistics of imports and exports were (and are) ultimately derived from and based upon the buying and selling, the “importing” and “exporting,” of each and every individual within the confines of the boundaries of the nation-state. Individuals are the “active” agents; the national trade data is merely a reflection of their producing and consuming, their buying and selling, their saving and investing decisions, both within the country and between them and the citizens of other nations around the world.

America’s Imports and Exports, and the Funding of Trade Deficits

As we saw, in 2016, the United States ran a balance of trade deficit of $502.3 billion. This amount is a dollar measurement of how much more Americans bought or acquired from abroad than they sold to those in other countries with whom they traded. It reflected the market choice of individuals and enterprises to take advantage of attractive trading opportunities at home and from abroad.

Every one of the transactions making up these national totals represented a free and voluntary exchange.

This net difference in imports over exports, the $502 billion trade deficit, represented and reflected the decisions by individuals in other countries to investment in the United States rather than purchase more immediate American exportable goods and services, and by Americans to take advantage of partnering opportunities with others in foreign lands. The estimate for direct foreign investment in the U. S. in 2016 comes to nearly $400 billion (which was a 12 percent increase over 2015). Most of the remaining more than $100 billion was in the form of indirect investments in the United States through financial institutions.

U.S. Imports and Exports Reflect the Choices of Americans

Every one of the transactions making up these national totals represented a free and voluntary exchange between a willing and able American consumer, enterpriser or investor with a comparable market partner from somewhere else around the world. Every one of the trades reflected a profitable opportunity for American and foreign consumers and producers and investors.

Each one of these trades and transactions generated a market outcome that the buying and selling, saving and investing participants considered as improving their well-being, their personal betterment, greater than the next best alternative from which they might have chosen either from a domestic or some other foreign market transaction.

Government Borrowing and the Dangers of Trade Deficits

So if fears and concerns about balance of trade deficits are misplaced in the interactions between individuals in markets within and between nations, does this mean that trade deficits are never a problem?

Unfortunately, it does not. The culprit is not in the private trades and transactions among competitive market participants, but in the halls of political power and decision-making. Governments have created balance of trade problems for their citizens due to the monetary and fiscal policies they have pursued.

Modern history is littered with instances of governments all over the world that borrowed huge sums of money from foreign lenders on the global financial markets, and found themselves unable to pay off the creditors. Greece in Europe and Puerto Rico in the Caribbean are just two of the most recent examples.

Free trade with limited and fiscally restrained government remains the best policy for liberty and prosperity.

Governments have sold their bonds to fund vote-buying welfare state spending, or expanding bureaucracies with loyal supporters of power-hungry politicians, or on delusional dreams of military power, or colossal public works projects hailing the greatness of the dictatorial or democratically elected leader. And a time has often been reached when domestic taxes and foreign exchange earnings from the sale of exported goods have been insufficient to cover principle payments and interest charges coming due.

Now, of course, private individuals also can over extend themselves with excessive consumer debt or investment misjudgments that fail to generate the revenues out of which debts are expected to be paid back. But unless fed by a monetary expansion that systematically generates business malinvestments, misdirected consumer spending and misallocated resources that affect the economy as a whole, individual entrepreneurial investment errors or spendthrift consumption choices on credit are "localized" and decentralized in their impacts on market activities.

But governments can promise to domestic and foreign lenders that nation’s "full faith and credit," which means a lien on future taxes collected, along with fancy bookkeeping that rising debt is really not as big and as serious a problem as some might claim – until the day of reckoning arrives. Hence, a balance of trade deficit may be created through government’s irresponsible borrowing and spending that can set the stage for a financial crisis down the road.

Free trade with limited and fiscally restrained government, which means individual freedom to live and choose in the competitive marketplace, remains the best policy for liberty and prosperity.