Trade gap plunges; feel better now

For decades, we've been told that rising trade deficits were a bad thing. In November, the US trade deficit shrivelled by 29 per cent. But don't get the party favours out yet, says Investor's Business Daily (IBD).

The common wisdom that trade deficits are a sign of weakness and lost competitiveness is a myth. In fact, the opposite is true: Trade deficits tend to climb when the economy is strong, and fall when it's weak. This is certainly the case now. November's $40.4 billion gap was the smallest in five years and the fourth monthly decline in a row. Both exports and imports fell – a sign of global recession. So the deficit is shrinking – but don't cue the applause, says IBD.

Contrary to what some assert, a smaller deficit isn't a "drag" on the economy. Nor is it a sign of economic health. Just look at recent history, says IBD:

  • From the end of the recession in 2001 to 2006, a time of solid economic growth in the U.S. economy, the trade deficit surged to record levels.

  • But, as economist David Malpass of Encima Global has noted, during that time the United States created some 9.3 million jobs.

  • Japan, by comparison, created just 360,000 new jobs, and Europe – excluding Spain – created just 1.1 million.

  • Like the United States, Spain ran big deficits; it created 3.6 million new jobs – more than three times the rest of the Euro zone combined.

    This isn't new, says IBD. As trade economist Dan Griswold of the Cato Institute noted in a 2007 study, there's an inverse relationship between trade deficits and the economy. The faster the economy grows, the greater the trade deficit. And vice versa:

  • In those years since 1980 in which the current account (the broadest measure of trade) deficit actually shrank as a share of gross domestic product, real GDP growth averaged 1.9 per cent.

  • But when the trade gap grew .5 per cent or more, he added, real GDP growth averaged 4.1 per cent.

  • This means the economy grew roughly twice as fast when the trade deficit was getting "worse" than when it was getting "better."

    The last time the United States ran a trade surplus for a full 12 months was 1991 – a recession year. Anyone who still believes that surpluses are good must be longing for the good old days of the Depression. Thanks to plunging consumer spending and the Smoot-Hawley tariffs, the United States ran trade surpluses in nine of the 10 years of the 1930s.

    Source: Editorial, Trade Gap Plunges; Feel Better Now? Investor's Business Daily, January 14, 2009.

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    For more on Trade Issues:

    FMF Policy Bulletin/ 27 January 2009
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