Are trade deficits good? Ask 60 years' worth of data

Peter Navarro's views, along with those of Wilbur Ross, that reducing the U.S. trade deficit would increase economic growth have created a firestorm that continues to burn.  They have been attacked from all portions of the political spectrum for their position that a reduction in the trade deficit as a percentage of GDP would lead to increased GDP growth.

Supporters of Navarro's position have appeared, but there has been an overwhelming onslaught of opinion pieces against them.  Effectively, Navarro is opposing the mainstream academic economic view.  For that, he has been accused (wrongly, we argue) of making rookie-level mistakes in interpreting the fundamentals of his discipline.

The arguments against Navarro can be summarized as follows: (1) the equation for GDP (GDP = G + C + I + NX; where G is government purchases, C is consumption, I is investment, and NX is net exports) only subtracts the trade deficit (a negative NX) because imports are already included in G, C, and I, and thus, it is just an accounting trick that in no way implies that a trade deficit is bad for economic growth; and (2) reducing the trade deficit by curtailing imports and promoting increased consumption of domestic goods and services will only drive up the costs for consumers, thereby harming economic growth.

Both of these concerns can be summarily dismissed with two graphs using six decades of empirical economic data for the United States.  Unfortunately, there has been little use made of actual data and their relationships in the debates over the trade balance, leading to arguments that are unnecessarily verbose.

If the trade balance does not affect economic growth, there should be no long-term relationship between these two variables. On the other hand, if running massive trade deficits is positive for economic growth (as Navarro's opponents either outright argue or strongly imply), there should be a negative relationship between the variables (i.e., higher trade deficits lead to greater economic growth).  Finally, if trade deficits harm economic growth, the relationship between the variables should be positive, meaning that higher trade deficits should correlate with lower rates of growth.

One must acknowledge in advance that there are many influences on economic growth, and a relationship between two variables does not prove causation; it is merely supportive of causation.  Alternatively, only by engaging in fanciful feats of multivariate econometric analyses coupled with substantial hand-waving can one attempt to make a case that a desired causation exists when the straightforward correlation opposes your theories.

In the first plot, we consider the external balance on goods and services (the value of exports of goods and services less imports of goods and services) versus nominal GDP growth for the U.S. since 1960.  There is a high level of statistical significance (p = 0.0005), and the slope is positive (+0.71) with a 95% confidence interval that includes 1.0 (0.71 +/- 0.39 – or that for every 1% of GDP increase in the trade deficit, nominal GDP growth is decreased by 1%).  What this means is that over six decades of data, trade deficits correlated extremely strongly to lower – not higher, nor even neutral – economic growth.  Thus, the actual data show a relationship heading in the opposite direction from what the free trade activists believe.  That alone causes serious problems for their case.

In addition, the slope of the relationship is supportive of the view that despite all the underlying complexities in the GDP formula, subtracting the trade balance is far more than just an accounting procedure.  There are, as one might suspect, real economic costs in choosing to purchase goods and services from outside a country rather than internally.  Trade is not all benefits, as the proponents argue, and the failure to adequately consider the empirical data when shaping economic theories and trade policies has done significant damage in recent decades.

As for the second branch on which Navarro's critics have placed their hopes – that reducing imports will drive up costs of goods and services and thereby damage the economy – if such were the case, we may expect to find lower rates of real economic growth with trade surpluses.  In other words, as the U.S. moved from chronic trade surpluses to endemic trade deficits over the past 60 years, the rates of real economic growth should be increasing with the influx of cheap imports.  As the second plot of the external balance on goods and services versus real (inflation-adjusted) GDP growth shows, this is not the case.  When the economy grows in real terms, it grows more rapidly when a trade surplus is present.

These are all inconvenient truths to the free trade-boosters.  There is a strong case, founded in both empirical and theoretical terms, to support Navarro's position on the trade deficit.  Ross Perot started this discussion back during the second 1992 presidential debate:

We have got to stop sending jobs overseas.  It's pretty simple: If you're paying $12, $13, $14 an hour for factory workers and you can move your factory South of the border, pay a dollar an hour for labor, ... have no health care – that's the most expensive single element in making a car – have no environmental controls, no pollution controls and no retirement, and you don't care about anything but making money, there will be a giant sucking sound going south ... when [Mexico's] jobs come up from a dollar an hour to six dollars an hour, and ours go down to six dollars an hour, and then it's leveled again.  But in the meantime, you've wrecked the country with these kinds of deals.

Fast-forward more than a quarter-century, and every nation in the West failed to heed Perot's warning.  The jobs went overseas, real wages stagnated, the Rust Belts accelerated their rusting, and real economic growth trended toward zero.  A return to more nationalist economic policies throughout the West will stop the wealth flow to authoritarian regimes being propped up by capital flows from their cheap imports flooding the West and who show no signs of democratizing, improve our collective national securities by allowing us to properly fund individual militaries and the collective defense network, and – most importantly – increase the standard of living for freedom-loving citizens.

Peter Navarro's views, along with those of Wilbur Ross, that reducing the U.S. trade deficit would increase economic growth have created a firestorm that continues to burn.  They have been attacked from all portions of the political spectrum for their position that a reduction in the trade deficit as a percentage of GDP would lead to increased GDP growth.

Supporters of Navarro's position have appeared, but there has been an overwhelming onslaught of opinion pieces against them.  Effectively, Navarro is opposing the mainstream academic economic view.  For that, he has been accused (wrongly, we argue) of making rookie-level mistakes in interpreting the fundamentals of his discipline.

The arguments against Navarro can be summarized as follows: (1) the equation for GDP (GDP = G + C + I + NX; where G is government purchases, C is consumption, I is investment, and NX is net exports) only subtracts the trade deficit (a negative NX) because imports are already included in G, C, and I, and thus, it is just an accounting trick that in no way implies that a trade deficit is bad for economic growth; and (2) reducing the trade deficit by curtailing imports and promoting increased consumption of domestic goods and services will only drive up the costs for consumers, thereby harming economic growth.

Both of these concerns can be summarily dismissed with two graphs using six decades of empirical economic data for the United States.  Unfortunately, there has been little use made of actual data and their relationships in the debates over the trade balance, leading to arguments that are unnecessarily verbose.

If the trade balance does not affect economic growth, there should be no long-term relationship between these two variables. On the other hand, if running massive trade deficits is positive for economic growth (as Navarro's opponents either outright argue or strongly imply), there should be a negative relationship between the variables (i.e., higher trade deficits lead to greater economic growth).  Finally, if trade deficits harm economic growth, the relationship between the variables should be positive, meaning that higher trade deficits should correlate with lower rates of growth.

One must acknowledge in advance that there are many influences on economic growth, and a relationship between two variables does not prove causation; it is merely supportive of causation.  Alternatively, only by engaging in fanciful feats of multivariate econometric analyses coupled with substantial hand-waving can one attempt to make a case that a desired causation exists when the straightforward correlation opposes your theories.

In the first plot, we consider the external balance on goods and services (the value of exports of goods and services less imports of goods and services) versus nominal GDP growth for the U.S. since 1960.  There is a high level of statistical significance (p = 0.0005), and the slope is positive (+0.71) with a 95% confidence interval that includes 1.0 (0.71 +/- 0.39 – or that for every 1% of GDP increase in the trade deficit, nominal GDP growth is decreased by 1%).  What this means is that over six decades of data, trade deficits correlated extremely strongly to lower – not higher, nor even neutral – economic growth.  Thus, the actual data show a relationship heading in the opposite direction from what the free trade activists believe.  That alone causes serious problems for their case.

In addition, the slope of the relationship is supportive of the view that despite all the underlying complexities in the GDP formula, subtracting the trade balance is far more than just an accounting procedure.  There are, as one might suspect, real economic costs in choosing to purchase goods and services from outside a country rather than internally.  Trade is not all benefits, as the proponents argue, and the failure to adequately consider the empirical data when shaping economic theories and trade policies has done significant damage in recent decades.

As for the second branch on which Navarro's critics have placed their hopes – that reducing imports will drive up costs of goods and services and thereby damage the economy – if such were the case, we may expect to find lower rates of real economic growth with trade surpluses.  In other words, as the U.S. moved from chronic trade surpluses to endemic trade deficits over the past 60 years, the rates of real economic growth should be increasing with the influx of cheap imports.  As the second plot of the external balance on goods and services versus real (inflation-adjusted) GDP growth shows, this is not the case.  When the economy grows in real terms, it grows more rapidly when a trade surplus is present.

These are all inconvenient truths to the free trade-boosters.  There is a strong case, founded in both empirical and theoretical terms, to support Navarro's position on the trade deficit.  Ross Perot started this discussion back during the second 1992 presidential debate:

We have got to stop sending jobs overseas.  It's pretty simple: If you're paying $12, $13, $14 an hour for factory workers and you can move your factory South of the border, pay a dollar an hour for labor, ... have no health care – that's the most expensive single element in making a car – have no environmental controls, no pollution controls and no retirement, and you don't care about anything but making money, there will be a giant sucking sound going south ... when [Mexico's] jobs come up from a dollar an hour to six dollars an hour, and ours go down to six dollars an hour, and then it's leveled again.  But in the meantime, you've wrecked the country with these kinds of deals.

Fast-forward more than a quarter-century, and every nation in the West failed to heed Perot's warning.  The jobs went overseas, real wages stagnated, the Rust Belts accelerated their rusting, and real economic growth trended toward zero.  A return to more nationalist economic policies throughout the West will stop the wealth flow to authoritarian regimes being propped up by capital flows from their cheap imports flooding the West and who show no signs of democratizing, improve our collective national securities by allowing us to properly fund individual militaries and the collective defense network, and – most importantly – increase the standard of living for freedom-loving citizens.