Recent government releases of trade data have Americans concerned. The monthly trade deficit increase in July and was approximately $10 billion higher than in July of 2009. It got even larger in August and September 2010. The National Income and Products Accounts definition of the goods and services trade deficit found the deficit had increased to an annualized -$515 billion in the third quarter of 2010 -- $124 billion larger than it was in the third quarter of 2009. (Data are real, annualized)
The data speaks for itself but the press and politicians have generated only misinterpretation and confusion. As usual – they are more concerned about winning friends and votes than they are about faithful interpretation. A worsened trade deficit is nothing to be happy about – but there is much more to this picture. The graph below has annualized quarterly real net exports of goods and services (annualized exports of goods and services minus annualized imports of goods and services) for all quarters between 1995 and the third quarter of 2010. The most noticeable aspects of the graph are the deterioration of net exports between 1995 and 2005 and the subsequence reversal in trend starting in late 2006. The eyeball easily sees that NET EXPORTS ARE IMPROVING.
While it is true that there was a deterioration in a few quarters since late 2006, the overwhelming story is the improvement. But as I will explain below, the recent improvement in net exports has very little to do with US trade competitiveness and should not be interpreted as a return to normal. It has more to do with large and erratic quarterly swings in our appetite for foreign goods. Inasmuch, there is little that policymakers can or should react to from these recent quarterly changes. Clearly, the one-quarter data does not suggest a need to cajole China or anyone else.
While it is true that the one-quarter change of -$106 billion in 2010 QII looks large, it does not necessarily bode ill. We have to wait and see. In fact, a closer look at the quarterly net export changes reveals a very large increase in quarterly variability since 2006 – the standard deviation was approximately $50 billion per quarter. That means that the large one-quarter change of - $111 billion in 2010 QII was within 2 standard deviations of the mean change since 2006 of $17 billion. This means that $111 billion falls within the 95% confidence interval and therefore is not an unlikely outcome. With this kind of volatility it would not be surprising to see net exports improve by $111 billion in 2010 QIV.
A second issue is the erroneous interpretation. When we read that net exports are deteriorating we question the ability of US firms to compete globally. While net export changes are the result of changes in both exports AND imports – we often focus only on the export side. The misleading interpretation is the conclusion that if net exports are worsening, then it must be because US firms cannot compete anymore. Or perhaps it means that China is an unfair trader – slapping egregious import tariffs on our goods or manipulating its currency. Clearly there must be some unfair practices in China and abroad or our US companies would do better. If we are having trouble selling goods abroad, the story goes, then this is hurting our recovery from the recession and is having a negative impact on workers who produce exports. Let’s face it – it’s a chilling story and it gives our politicians a way to ride in on their silvery steeds and save the day against those unfair and mean enemies.
Of course, none of this is true insofar as recent events are concerned. US exports increased by $225 billion in the last five quarters – an increase of more than 15% in real terms. Exports increased in every one of those five quarters and by amounts ranging from $20 to $84 billion per quarter. If anything – it has been these increases in exports that have sustained the US economy and prevented job growth from being even worse!
It turns out, however, of you want to talk about US Net Exports for the entire time period and the key sub-periods – the trade story is about IMPORTS not exports. The below chart – if it is readable on the blog – shows the quarterly changes in exports (blue diamond) and imports (red squares) since 1995.
Here’s is what we should notice –
First, in the vast majority of quarters from 1995 to 2005 – the imports are above the exports – meaning that no matter how much exports increased in a particular quarter – imports increased by more. We can really suck in foreign goods!
Second, in the time period directly afterward 2005 – the changes in imports declined and then went negative. As the recession approached and worsened and US incomes decreased – we quit spending. We stopped buying all goods – both domestically produced and imported. Export changes also shriveled but by less than the imports. So net exports improved! So for a while we see net exports improving not so much because US firms were more competitive in global markets – but because the US was hurting and our populations was buying less.
Third, in the final five quarters – 2009 QIII to 2010 QIII – we see the US economy starting to recover and our appetite for goods returning. Despite the large and positive swing in exports – imports started rising even more and the trade deficit worsened in 2010.
Fourth – looking at the chart you see that these recent changes in imports are probably unsustainable – since they are well out of line with the past history of import changes. The export recovery seems much more sustainable.
In summary, recent changes in net exports tell us less about changing competitiveness of US firms and more about the appetites of US consumers and firms. Increased volatility of net exports warns us not to make too much of one-quarter changes of the recent past and coming future. If we want to restore the US to balanced trade, the data suggests we should think more about how and why US households and firms increasingly look abroad for their purchases. If foreigners are so willing to buy US goods – why aren’t we? Pointing the finger at China might not be so smart. Our world exports are doing well.