Modern economists are split on the economic impact of the trade deficit with some viewing it as a loss in a fixed volume of trade and more radical Neoliberal voices who claim it is a sign of economic strength.
The traditional view opposes long run trade deficits and outsourcing for the sake of labor arbitrage to obtain cheap labor as an example of absolute advantage which does not produce mutual gain, and not an example of comparative advantage which does.
Neoliberal economists claim that trade deficits are beneficial, noting the correlation between increasing trade deficits and increasing GDP and employment ([1]). An expanding economy means increased demand for domestic and foreign products. This rising demand promotes domestic investment as both foreign and domestic businesses seek to capitalize on the growth in demand. As the rate of growth accelerates foreign credit sources have greater incentives to invest in a growing nation's capital. The greater net inflows from abroad, the greater the trade deficit. Thus, GDP growth can be correlated with a trade deficit. However, these economists seem to ignore the fact the excessive borrowing may artificially inflate GDP.
Strong GDP growth economies such as the United Kingdom, Australia, Hong Kong and the United States run consistent trade deficits.
On the other hand, GDP growth may be due to excess borrowing to fund consumption and not an expansion of the base of an economy.[4] Developed nations such as Canada, Japan, and Germany typically run trade surpluses. China also has a trade surplus. A higher savings rate generally corresponds with a trade surplus. In 2006, the United States has its lowest savings rate since 1933.[5] Correspondingly, the United States has high trade deficits. The general decline of Great Britain is another example of the deleterious effects of long term trade deficits.
Some contend long term effects of the trade deficits are deleterious. Since the stagflation of the 1970's, the U.S. economy has been characterized by somewhat slower growth. In 1985, the U.S. began its growing trade deficit with China. In 2006, the primary economic concerns have centered around: high national debt ($9 trillion), high corporate debt ($9 trillion), high mortgage debt ($9 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position (NIIP) (-24% of GDP),[6] high trade deficits, and a rise in illegal immigration. These issues have raised concerns among economists and unfunded liabilites were mentioned as a serious problem facing the United States in the President's 2006 State of the Union address.
Large imbalances may sometimes be a sign of underlying economic problems or rigidities. An example would be a situation where exchange rates have been fixed or pegged for political reasons at levels impeding a correction of a trade imbalance.
The trade deficit must be "financed" by foreign income or transfers, or by a capital account surplus. This includes inward foreign investment and capital purchases (stocks, bonds ect). An increase in net foreign liabilities tends to lead to an increase in the net outflow of income on international investments.
Those in favor of the trade deficit point to this financing as the source of the benefit. Instead of buying goods back, buyers in the receiving country send the money back in the form of capital. A firm in America sends dollars for Chinese toys, and the Chinese receivers use the money to buy stock in an American firm. Although this is a form of financing, it is not a debt on any party in America.
Such payments to foreigners have intergenerational effects: by shifting consumption over time, some generations may gain at the expense of others . However, a trade deficit may lead to higher consumption in the future if, for example, it is used to finance profitable domestic investment, which generates returns in excess of that paid on the net foreign liabilities (a situation that might arise if a country experiences an unexpected gain in productivity). Similarly, a surplus on the current account implies an increase in the net international investment position and the shifting of consumption to future rather than current generations.
However, trade imbalances are not always indicative of the smooth operation of the market given differences in international productivity and intertemporal consumption preferences. Trade deficits have often been associated with a loss of international competitiveness, or unsustainable 'booms' in domestic demand. Similarly, trade surpluses have been associated with policies that inefficiently bias a country's economic activity towards external demand, resulting in lower living standards. An example of an economy which has had a positive balance of payments was Japan in the 1990s. The positive balance was partly the result of protectionist measures that brought excessive profits to Japanese exporters.
The traditional view opposes long run trade deficits and outsourcing for the sake of labor arbitrage to obtain cheap labor as an example of absolute advantage which does not produce mutual gain, and not an example of comparative advantage which does.
Neoliberal economists claim that trade deficits are beneficial, noting the correlation between increasing trade deficits and increasing GDP and employment ([1]). An expanding economy means increased demand for domestic and foreign products. This rising demand promotes domestic investment as both foreign and domestic businesses seek to capitalize on the growth in demand. As the rate of growth accelerates foreign credit sources have greater incentives to invest in a growing nation's capital. The greater net inflows from abroad, the greater the trade deficit. Thus, GDP growth can be correlated with a trade deficit. However, these economists seem to ignore the fact the excessive borrowing may artificially inflate GDP.
Strong GDP growth economies such as the United Kingdom, Australia, Hong Kong and the United States run consistent trade deficits.
On the other hand, GDP growth may be due to excess borrowing to fund consumption and not an expansion of the base of an economy.[4] Developed nations such as Canada, Japan, and Germany typically run trade surpluses. China also has a trade surplus. A higher savings rate generally corresponds with a trade surplus. In 2006, the United States has its lowest savings rate since 1933.[5] Correspondingly, the United States has high trade deficits. The general decline of Great Britain is another example of the deleterious effects of long term trade deficits.
Some contend long term effects of the trade deficits are deleterious. Since the stagflation of the 1970's, the U.S. economy has been characterized by somewhat slower growth. In 1985, the U.S. began its growing trade deficit with China. In 2006, the primary economic concerns have centered around: high national debt ($9 trillion), high corporate debt ($9 trillion), high mortgage debt ($9 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position (NIIP) (-24% of GDP),[6] high trade deficits, and a rise in illegal immigration. These issues have raised concerns among economists and unfunded liabilites were mentioned as a serious problem facing the United States in the President's 2006 State of the Union address.
Large imbalances may sometimes be a sign of underlying economic problems or rigidities. An example would be a situation where exchange rates have been fixed or pegged for political reasons at levels impeding a correction of a trade imbalance.
The trade deficit must be "financed" by foreign income or transfers, or by a capital account surplus. This includes inward foreign investment and capital purchases (stocks, bonds ect). An increase in net foreign liabilities tends to lead to an increase in the net outflow of income on international investments.
Those in favor of the trade deficit point to this financing as the source of the benefit. Instead of buying goods back, buyers in the receiving country send the money back in the form of capital. A firm in America sends dollars for Chinese toys, and the Chinese receivers use the money to buy stock in an American firm. Although this is a form of financing, it is not a debt on any party in America.
Such payments to foreigners have intergenerational effects: by shifting consumption over time, some generations may gain at the expense of others . However, a trade deficit may lead to higher consumption in the future if, for example, it is used to finance profitable domestic investment, which generates returns in excess of that paid on the net foreign liabilities (a situation that might arise if a country experiences an unexpected gain in productivity). Similarly, a surplus on the current account implies an increase in the net international investment position and the shifting of consumption to future rather than current generations.
However, trade imbalances are not always indicative of the smooth operation of the market given differences in international productivity and intertemporal consumption preferences. Trade deficits have often been associated with a loss of international competitiveness, or unsustainable 'booms' in domestic demand. Similarly, trade surpluses have been associated with policies that inefficiently bias a country's economic activity towards external demand, resulting in lower living standards. An example of an economy which has had a positive balance of payments was Japan in the 1990s. The positive balance was partly the result of protectionist measures that brought excessive profits to Japanese exporters.
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