America Cannot Continue to Absorb Global Imbalances
The implacable trade deficits run by the United States since the late 1970s have been, and continue to be, costly to the American economy. For decades, the implicit and explicit subsidies to manufacturers that have driven surpluses in countries like China and Germany have caused global manufacturing to migrate from deficit countries to surplus countries, and from none more so than the largest deficit country by far, the United States. What is more, as I wrote in “Bad Trade,” published by American Compass, American trade deficits force Americans to choose between higher unemployment, more household debt, or greater fiscal deficits. They have helped drive the surge in American debt for nearly five decades.
It is important to understand the U.S. trade deficit within the context of global trade. In spite of the World Trade Organization (WTO) and other global entities designed to enforce free trade, the world is experiencing one of the most mercantilist periods in history.
Conventional wisdom holds that countries that run persistent trade surpluses do so because their populations are especially hard-working and thrifty and their manufacturers especially efficient at production. This is simply not true. The reward for successful exporting would not be trade surpluses, but rather the ability to import ever greater amounts of foreign goods in exchange for those exports at constantly improving terms of trade.
In a well-functioning trade environment, countries would not be able to run large, persistent surpluses or deficits, mainly because these surpluses or deficits would force changes in their respective economies that would automatically eliminate them. The fact that we live in a world with the largest, most persistent trade imbalances in history is more than sufficient proof that mercantilist policies in individual economies are preventing the necessary adjustments that make free trade beneficial for the world.
In the modern global economy, countries achieve “competitiveness” not by raising worker’s productivity but rather by indirectly suppressing wages. Countries run persistent trade surpluses because total domestic demand is insufficient to absorb all that is produced, and the reason demand is so low is because workers in these countries are paid too low a share of what they produce to be able to afford to consume it. Surplus countries, in other words, are simply countries in which domestic policies implicitly or explicitly force workers and the middle classes to subsidize manufacturers. This is not mainly a matter of low wages. It is a matter of low wages relative to productivity, which is why nominally high-wage countries, like Germany or Japan, are as mercantilist as lower-wage countries, like China.
This is why countries that run large, persistent surpluses are harmful to the global economy. Their surpluses are mainly the result of policies that directly and indirectly subsidize manufacturing growth through policies that suppress domestic demand, and it is precisely those surpluses that allow them to force the demand-suppressing cost of their policies onto their trading partners.
Thus, the role that the United States plays in the global economy. Because it is the absorber of last resort for excess foreign savings, it must also be the consumer of last resort for excess production, which means foreign manufactures have privileged access to American consumers relative to American manufacturers. It is not in the best interest of the American economy that it continues to play this role.
Unfortunately, decades of attempts to intervene in trade have done little to reverse American trade deficits. That’s because these interventions are based on obsolete trade models that misunderstand the relationship between capital flows and trade imbalances. Most mainstream economists implicitly assume (often without realizing it) that trade deficits are caused mainly by differences in comparative advantage or by production cost differentials, and that foreign capital surpluses flowing into the United States are mainly responding to these deficits.
But this hasn’t been the case for decades. In today’s world, foreigners do not fund U.S. trade deficits. They direct their excess savings into the U.S. financial market mainly to take advantage of its depth, liquidity, and governance. Whether it is oligarchs parking their wealth, central banks managing their currencies, flight capital, speculators looking for liquid assets, or mercantilist economies that must acquire foreign assets to balance their surpluses, nearly half of the excess savings of the world is dumped regularly into U.S. financial markets, with much of the rest going to the most similar financial markets, mainly in the UK, Canada and Australia.
But the balance of payments must balance. If foreigners pour capital into the United States, the United States must run an equivalent trade deficit, even if that foreign capital simply represents the desire of foreigners to acquire American farmland, factories, stocks, bonds, property and so on. As countries like China or Germany implement mercantilist policies that force up their domestic savings rates, and directly or indirectly pour these excess savings into the United States, China and Germany must run trade surpluses and the United States has no choice but to run a corresponding trade deficit.
For that reason, trade tariffs and other forms of trade restriction are insufficient to eliminate American trade deficits. Because these restrictions have no impact on the savings imbalances in the mercantilist countries, as long as the United States continues to allow unfettered foreign acquisition of its assets, it will continue to run the large trade deficits needed to accommodate the transactions. Global trade, after all, must balance, and the United States provides the main balancing role.
If the United States wants to eliminate its trade deficits, it must change tactics. Rather than restrict trade, the policymakers must restrict the ability of countries that run persistent trade surpluses to dump their excess savings into U.S. financial markets. They should unilaterally restrict harmful capital inflows in ways that leave productive, long-term investment in the American economy unaffected.
Of course, restricting inflows will partially undermine the global dominance of the U.S. dollar, so the necessary policies will almost certainly be opposed by Wall Street, by billionaire owners of highly mobile capital, and by the foreign policy establishment. They will however benefit American manufacturers, workers, small businesses, and middle-class savers, and ultimately will result in a healthier, stronger American economy and industrial base with a larger share of global manufacturing.