Decreasing Trade Deficit Not So Good

In a recent article in the Wall Street Journal titled: “Trade Slump Spreads Pain Across Globe,” it was reported that the U.S. Trade Deficit has shrunk significantly to approximately $36 billion. This news should be perceived positively right? After all, it means that Americans are importing less foreign goods therefore reducing our dependency upon them and bringing the nation’s balance of payments closer to equilibrium right? Interpreting the data in this manner is misleading. The primary reason for a declining trade deficit can be attributed to the poor state of the economy. The current state of the Economy has discouraged everyone from the business sector to individual households from making additional purchases. All have scaled back and settled for only the immediate and necessary purchases. If times were good, economically speaking, most likely the deficit would be growing. The truth is that Americans are still highly dependent on foreign goods, especially oil which constitutes a large portion of that deficit. The United States will not see a truly significant decrease in the trade deficit until it provides alternative forms of energy to reduce its dependence on foreign oil. In the meantime, the decline in trade could actually be seen as harmful to all participating economies. The decrease in trade has been mostly among consumer goods that are more elastic to changes in market conditions. Assuming a basic economic theory to be true, that trade makes everyone better off, the recent decline in trade harms standards of living in all participating parties. Consumers in the United States have less consumer choices and their trading partners receive less income. Layoffs as well are becoming more frequent among parties. It is fast becoming a downward slope.

Trade Slump Spreads Pain Across Globe


Dr. Tufte said...

-1 on Tristan for a capitalization error.

There are quite a few misconceptions to clean up in this post. No knock on Tristan: this is all standard nonsense that we get fed by the media and the government. The general point that a declining trade deficit might not be a good thing still holds.

1) The trade deficit is a flow, so the correct figure is not "$36B". It has to be $36B per unit of time. My guess is that this is per month.

2) The media strongly sells this idea that a trade deficit is a bad thing. If this is the true, then the trade deficit you have with Wal-Mart is a bad thing too. Since it isn't, a trade deficit isn't bad either. This is just another case of the media's obsession with labeling first and thinking second (if at all).

3) The U.S. has flexible exchange rates. By definition, this means our payments are always in balance. Worries about the balance of payments are a leftover from when we didn't have flexible exchange rates (prior to 1971). Talking about this is a sign - to someone who understands the issues - that you don't know what you're talking about. Again, the balance of payments gets brought up frequently by the legacy media.

4) Many people claim that "alternative energy" will address our trade deficit. How do they know? My guess is that they don't. It's perfectly conceivable that we might end up importing most of our alternative energy. Our buddy Canada is praying for this: most of the world's hydropower would come from there.

5) After this, there's a jump, and this might be Tristan's fault: a decline in our trade deficit and a decline in trade are not the same thing. They have both happened concurrently, and are probably related, but you can't impute that from what we know. To see this, let D=X-M, where D is the deficit, X is exports, and M is imports. A decrease in trade means that both X and M get smaller. This could mean that D gets larger or smaller.

Most of the problems outlined above above are illustrative of a general problem in understanding economics: mistaking symptoms for causes.

Tristan said...

I’m glad the general point that a declining trade deficit doesn’t necessarily constitute a good thing was discernible. Admittedly, the information could have been presented a little more clearly. I hope the following comments will clarify some of the misperceptions.

It occurred to me that some may not have access to the Wall Street Journal on-line article so I found a similar article in the Deseret News titled: “Trade deficit falls to $36 billion in January” http://deseretnews.com/article/1,5143,705290616,00.html I hope all will now be able to access the information presented in the article.

1) To clarify, the deficit decrease to $36 billion was for the month of January, which the article reports was a 9.7% drop from the previous month of December 2008.

2) In regard to alternative energy’s impact on the trade deficit, Dr. Tufte is absolutely right. Nobody really knows if resorting to alternative energy would have any impact at all, but as we have learned in class, there isn’t necessarily any right or wrong answers in Macroeconomics sometimes so what does it hurt to speculate? Assuming the United States were able to provide their own sources of alternative energy while simultaneously reducing dependency on foreign oil and also assuming no adverse effects on exports, this would theoretically reduce the trade deficit by reducing imports no?

3) Lastly, again Dr. Tufte is correct in highlighting that a decline in trade and a decline in the trade deficit are not the same thing. I felt the article was clear in its first few paragraphs explaining that imports had dropped 6.7% as well as exports by 5.7% thus indicating an overall decline in trade. For this reason alone I suggested a decline in trade which seems to hold true under the D= X-M model. The decline in the deficit here is also made evident in that imports dropped more rapidly than exports. So, as Dr. Tufte notes, in this instance they just so happened to occur concurrently. I should have more clearly highlighted these facts.

Tristan said...

An idea occurred to me regarding the United States dependence on certain forms of foreign energy. Wouldn't the United States be much more self-sufficient energy wise if we didn't have organizations such as the Environmental Protection Agency? Such organizations hinder us from acquiring the maximum benefit from resources within our own borders. Employing a cost-benefit analysis, I suppose we might be better off financially, but really the question can't be answered efficiently because who would determine what the monetary value of hiking Zion National Park would be or fly-fishing in a clean river? Everyone would assign such assets a different value.

Liam said...

I wouldn't go to the extent of saying people would choose a clean air, as opposed to it being imposed on them. The Chinese allow for growth and produced over 3 trillion kWh of electricity in 2007. I hadn't heard of a specific regulatory agency that protects their landscape, but I know that they are doing a "great" job at maintaining the beauty of their land and sky. During the Olympics of 2008, we all remember the mandate that the residents of Beijing got from their government. To Residents: STOP DRIVING FOR THE SAKE KEEPING THE SKY ONLY SEMI-BROWN.