John Locke Update / Research Brief

Trade Deficits Can Be Beneficial

posted on in Fiscal Insight, Spending & Taxes
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I was recently cleaning out some old files and came across an article on trade deficits and surpluses that I wrote in 1988 while working as an economist with the Institute for Research on the Economics of Taxation in Washington, D.C. At the time, it was distributed by the Institute for Humane Studies at George Mason University to newspapers across the country.  The particular clipping was from the March 17, 1988 issue of the Roanoke Times & World-News, and it is reprinted below.

Every generation seems to revive the mercantilist myth that trade deficits are bad for an economy and trade surpluses are good. This myth is so much a part of people’s thinking that it’s actually quite remarkable when a politician, such as Ronald Reagan back in the late 1980s, gets it right and pushes back on this relic of 16th and 17th century economics. Unfortunately, in 2019, there are few politicians who buy into the myth more than President Donald Trump. While I have written several articles explaining why the economics behind this claim are based on false premises, the article below explains why there is no empirical case for Trump’s mercantilist views and that typically trade deficits tend to be a sign of a strong economy.

Reagan Was Right: Trade Deficits Can Be Beneficial

The common perception that trade deficits are harmful to the economy is proof that if something gets repeated often enough, it becomes accepted as truth regardless of whether it has any basis in either fact or theory. So when President Reagan recently declared that our current trade deficit could actually be “a sign of [economic] strength” it was widely reported as a mere politically motivated statement.

But economists since Adam Smith have taken a different position. They have argued that the mercantilist claims about the “inherent evils” of trade deficits are false, and that public policies directed toward eliminating them are misguided.

Casual observation suggests that there is no historical evidence to support the view that trade deficits are harmful to the economy. Although trade surpluses have dominated the 20th century for the United States, through good times and bad, it is also true that every major U.S. recession has been accompanied by a trade surplus.

On the other hand, trade deficits have accompanied some periods of outstanding economic growth. As the administration is fond of pointing out, our current trade deficit has gone hand-in-hand with the longest period of sustained, peace-time economic growth since World War II.

More striking, though, is the period of the U.S. history generally viewed as bringing the most intensive and extensive economic growth – the second half of the 19th century. From 1851 to 1900, there were only 11 years in which the United States ran a trade surplus. In all of the remaining 39 years, the country ran a trade deficit.

At the very least, trade deficits have not been a sign of a bad economy and usually can be associated with significant economic growth. Common sense should tell us that a particularly prosperous country will be able to attract a relatively large proportion of the world’s goods and services – in the form of both consumer goods and investment.

This is not to argue that trade deficits are good for the economy and trade surpluses are bad. Neither deficits nor surpluses are inherently evil or virtuous. They simply describe the relative distribution of goods, services and a medium of exchange – in this case, dollars – that has resulted from decisions freely made. It just happens that these decisions are made by consumers and producers who live on different sides of political borders.

Nearly all of us have “trade deficits” with our local grocery and department stores – we spend more money with them than they spend with us – and we are happy to have the opportunity to create those deficits. The owners of these stores have a trade surplus with us, and we are equally happy. Why would the placement of an international border between our homes and the local supermarket suddenly make this balance detrimental?

Many problems are facing our economy that do curtail economic growth and therefore social welfare. We have a tax system that is biased against savings and capital-formation, a federal budget that siphons increasing amounts of resources from the private economy, and regulations that stifle investment and creativity. These things should be changed. But designing and executing policies specifically to curtail the trade deficit will create problems where no problem currently exists.

Roy Cordato is Senior Economist and Resident Scholar at the John Locke Foundation. From January 2001 to March 2017, he held the position of Vice President for Research at the Locke Foundation. He also holds the title of Lecturer at… ...

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