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Thursday, February 16, 2006
Slaying an Old Bogeyman

Chris at Lucky Dawg pointed me to this article by Pat Buchanan, where he rails against the US Trade Deficit:

Now that the U.S. trade deficit for 2005 has come in at $726 billion, the fourth straight all-time record, questions arise: What constitutes failure for a free-trade policy? Or is there no such thing? Is free trade simply right no matter the results?

Last year, the United States ran a $202 billion trade deficit with China, the largest ever between two nations. We ran all-time record trade deficits with OPEC, the European Union, Japan, Canada and Latin America. The $50 billion deficit with Mexico was the largest since NAFTA passed and also the largest in history.

When NAFTA was up for a vote in 1993, the Clintonites and their GOP fellow-travelers said it would grow our trade surplus, raise Mexico's standard of living and reduce illegal immigration.

None of this happened. Indeed, the opposite occurred. Mexico's standard of living is lower than it was in 1993, the U.S. trade surplus has vanished, and America is being invaded. Mexico now is the primary source of narcotics entering the U.S.

Okay, that last sentence should get a horselaugh. I would guess that Mexico has been the primary source of narcotics entering the US since about 1915. Buchanan's claim that Mexico's standard of living has declined since 1993 is absurd. I live in a border state and I can tell you that Mexico's standard of living has improved quite substantially in the last decade or so. In 1993, Mexico's GDP per capita was $3,200. In 2004, it was $9,600. By contrast, the US GDP per capita in 1993 was $22,470, almost exactly 7 times the per capita output of Mexico. In 2004, the US GDP per capita was $40,100, or a little more than 4 times the per capita output of Mexico. So both of us have gotten wealthier, but the Mexicans have been doing it a little faster. They're nowhere near as wealthy as we are, which is why we still have the immigration problem, but they're making significant progress.

But is the trade deficit really bad for the economy? Think about what a trade deficit means; essentially it means we are buying more from other countries than they are buying from us. It sounds like wealth is draining from our economy into others. Except, of course, that we aren't just tossing our money at Chinese manufacturers, we're getting something that we want in return: shirts, computer equipment, garden hoses, etc. So there's no real wealth lost; it's just monetary wealth exchanged for goods wealth.

Here's an interesting article on the trade deficit which pokes some holes in Buchanan's concerns.

Years in which the U.S. current account deficit - which largely consists of the trade deficit - is rising show stronger growth than years in which the current account deficit is shrinking. Let's first look at those years where the current account deficit shrank, which - according to conventional wisdom - should be a good thing. But the data says otherwise: In those years since 1980 when the current account deficit declined as a share of GDP, the economy grew by an annual average of only 1.9%.

In contrast, during those years in which the current account deficit grew moderately, real GDP grew at an annual average of 3.0%.

More astonishingly yet, in those years when the U.S. trade deficit "deteriorated" most rapidly, to borrow another popular characterization, real GDP grew by a robust annual average of 4.4%. In other words, growth in those years was more than twice as strong as in years when the deficit was "improving."

As a matter of fact, four of the five best years for U.S. GDP growth since 1980 have occurred in the same years when the U.S. current account deficit increased most rapidly.

The same pattern emerges in the U.S. manufacturing sector. It has become the conventional wisdom that a trade deficit hurts manufacturing activity in the United States, because imports presumably displace domestic production.

But the plain evidence of the past quarter century contradicts that general presumption. U.S. manufacturing output actually declined slightly on average in those years in which the U.S. current account deficit shrank.

In contrast, manufacturing output grew by 4.1% in years when the current account deficit grew moderately - and by a brisk 5.3% when the deficit grew rapidly.

I should point out here that I don't think that the high trade deficits lead to strong economic growth; I think the causality goes the other way. That is, strong economic grown leads to high and rising trade deficits, while poor economic growth leads to low and declining trade deficits.
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