With the threat of trade war in the air, the trade balance is once again getting a lot of attention. US president Donald Trump wants trade barriers to “protect” US jobs against foreign competition, and reverse the flows so the US stops being a net importer of goods.
Indeed, the US has had a negative trade balance since the 1970ies. Here in the UK, we last had a positive trade balance in 1998. Since then, we have also been importing more goods than we have been exporting. There are those who think this is inherently unsustainable, whereas others are less concerned and even look at appetite for consumption of foreign goods as a sign of underlying strength in the domestic economy. Who is right?
First, let’s look at what the trade deficit actually is. The balance of payments is a record of a country’s economic dealing with the rest of the world: the current account contains the import and exports of goods and services, and the capital account contains the movements of investments in and out of the country. The balance of current (or money and gold) account tallies up foreign exchange transaction. What is meant by the trade balance is a specific subgroup of the current account, namely one containing only imports and exports of merchandise (i.e. the current account less services). With a somewhat Mercantilistic terminology, the trade balance is said to be in deficit when imports exceed exports.
So while a trade deficit sounds ominous, it merely means that foreigners have invested into UK assets, and in return they have shipped consumption and capital goods over to us. Nothing wrong with that, if the money imported into the UK are indeed invested, allowing not just future consumption but also production of goods which can be sold abroad to enable the flow of capital to eventually reverse. What is not sustainable is a debt financed consumption fest. Borrowing from abroad to enable us to buy more consumer goods only works as long as the finance is made available. The day of reckoning arrives when it dawns on foreign creditors that there is no substance behind the IOUs, because nothing has been produced which will allow the money to be paid back. In other words, a trade deficit driven by insufficient domestic saving is bad, but one caused by a high appetite for investment from abroad is good. What matters is not who your creditors are but whether you can repay your debts.
Unfortunately, the trade balance alone doesn’t tell us what goods have been imported; and whether those goods are for consumption or investment matters. So does whether the foreign investment is a consumer loan or an equity injection into a company, and we can’t learn that from the trade balance either. Of course, J.M. Keynes was very concerned about trade deficits, and the central position it takes in public debate is very much in line with the Keynesian, consumption-led theories which dominate today’s economic policies. Donald Trump’s anti-trade ideas are based on ignorance, and it doesn’t help when even trained economists make simple mistakes. The trade deficit gets much more publicity than it deserves.