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bubbles, business investment, capital flows, capital spending, China, competitiveness, currency manipulation, global division of labor, global financial system, investment, manufacturing, Neil Irwin, subsidies, The New York Times, Trade, Trade Deficits, U.S. dollar, {What's Left of) Our Economy
At least Neil Irwin’s New York Times article yesterday on the real meaning of trade deficits made two points rarely seen in journalistic examinations of the subject. He acknowledged that these shortfalls subtract from an economy’s size. (And should have added that worsening trade balances slow an economy’s growth – a big problem for the slow-growing United States these days.) And he noted that the foreign investment inflow triggered by deficits should be put to productive uses. Otherwise, it can create dangerously bubbly effects, as with U.S. housing and personal consumption during the last decade.
What Irwin didn’t discuss were the real-world obstacles created by trade deficits to using those capital inflows wisely, and unfortunately, they’re much more important and germane to policymakers and the public.
For example, let’s say that a country’s trade deficit is heavily concentrated in manufacturing (which America’s is). And let’s say that it partly reflects not only the dollar strength resulting from the central role played by the United States in the global financial system, but foreign countries’ policies of artificially undervaluing their currencies. If Washington didn’t respond adequately, wouldn’t many prospective investors balk at pouring money into domestic manufacturing for fear of having to compete not only with foreign companies, but with foreign treasuries? And wouldn’t a turn-the-other-cheek American policy toward other foreign subsidies produce similar effects?
Alternatively, a large manufacturing-centered trade deficit could inhibit productive domestic investment by killing off large numbers of manufacturing jobs – which have long been among the economy’s best-paying. Investors considering building new factories in America could understandably be dissuaded by the resulting reductions in family incomes – which could well ripple far beyond manufacturing as displaced industrial workers began competing for the jobs remaining in the service sector, and undermined its own wage growth.
Another live possibility: If U.S. trade deficits significantly reflected the offshoring activities of multinational companies, and American trade policy encouraged the supply of the high price U.S. market from much lower cost (and lightly regulated) foreign markets, wouldn’t many of these multinationals take the hint and send much of their capital abroad?
Nor are these scenarios hypotheticals. If you look at the business investment share of the U.S. economy, as pointed out by Dean Baker of the Center for Economic Policy Research (in a recent email), it grew steadily between 1950 (when it was 9.99 percent of pre-inflation gross domestic product) to 1980 (when it hit 14.21 percent). By 2007, the last year before the Great Recession struck, it had fallen back to 13.27 percent. Last year, it stood at 12.83 percent. (Unfortunately, the inflation-adjusted data only go back to 1999.)
Of course, such capital spending is driven by many forces. Baker, for example, emphasizes the destructive effects of financial deregulation, which greatly increased the rewards of short-term-focused speculative activity versus the longer-term gains generated by funding production and innovation. But can it be a total coincidence that domestic American business investment peaked just as imports – especially from predatory trading powers like Japan – were starting to make big inroads into U.S. markets?
Even more suggestive: Research published in 2014 by analyst Aaron Ibbotson of Goldman Sachs showed that U.S.-owned multinationals have not simply stopped or slowed investing in new plant and equipment. Instead, they’ve increasingly channeled such investment overseas, especially to emerging market countries like China, in order to supply their industrial needs.
Not that these are the only problems potentially and actually created by running trade deficits – especially big, chronic ones – that Irwin missed. For instance, when foreign interests buy American assets with trade surplus earnings, they buy control over the U.S. economy. This arguably is not a significant issue when the buyers are other private companies, or when they come from countries that are allied or friendly with the United States, or neutral. When a large and growing share of these acquisitions are made by China – which is neither friendly, nor private sector dominated – threats emerge ranging from market distortions (created by heavily subsidized financing arrangements) to national security dangers.
Irwin should have also mentioned that changing trade balances are crucial indicators of global competitiveness, and in fact signal which countries are likely to be major and minor producers of various goods and services. Indeed, the ostensibly most efficient possible global division of labor that results is a principal justification for encouraging trade. If manufacturing, to take one sector, is judged to create no special advantages for the American economy, then it’s fine to be indifferent to trade deficit signals that U.S. industry’s world-class status is at risk. If manufacturing is prized, then the deficit is indeed a valuable scorecard, and one that’s sending a troubling message.
Of course, Irwin’s column also argued that the strong dollar that puts constant upward pressure on the trade deficit creates major diplomatic and national security benefits for the United States, and there are respectable, if not dispositive, arguments to be made along these lines. But when it comes to the domestic growth, employment, and wage impact of trade deficits – not to mention the effects on all the productivity growth and innovation fueled by manufacturing – portrayals of these shortfalls as close-calls or nothing-burgers belong in a set of political talking points, not in a supposed economic primer.
RealityChek 