The Goods Trade Deficit

President Trump has made the US goods trade deficit the center of his economic agenda. He believes that the US is being treated unfairly when it comes to trade in goods. He concludes that this is bad for US workers.

Since international trade is like a giant sausage or at least a meter-long bratwurst, let's try to ignore for a moment most of the aspects of international trade and just focus on the US goods trade deficit. As its name implies, we now focus on only goods. That means for the moment we are ignoring trading of services and various kinds of assets. As Joe Friday used to say, "just the facts on goods ma'am." Okay, he didn't really say that but I had fun saying it anyway. Goods are tangible things that tend to stick with you. So we can begin with sticky buns. Trade in goods includes other tangibles such as agricultural products, autos, trucks, computers, phones, and much more.

The international trade balance in goods equals goods exports minus goods imports. In 2017, the US exported almost $1.6 trillion in goods to other countries. That sounds pretty impressive. But keep in mind two things. First, in 2017 the total amount produced of all goods and services (Gross National Product) in the USA was close to $20 trillion. So in terms of the whole amount of production, goods exports was about 8% in 2017. I would call that peanuts except it might be taken as an insult to peanuts.

Second, we sold $1.6 trillion of goods to people in other countries -- but here's the kicker -- we bought about $2.4 trillion from them. My friend Chuckie T. says that is really cool. We got a lot of stuff, and we didn't have to make it ourselves. But that isn't how President Trump thinks. He would prefer for all that stuff to be made here by US workers. That deficit of about $807 billion is a black eye. It represents to him what the US is losing.

So for a moment, let's stick with the black-eye interpretation. As anyone who has ever suffered a black eye knows, it is not a thing to cherish  It hurts. One must remedy it, but before we start throwing around remedies, let's turn to a bigger picture.

The goods balance has been negative since 1971. I found that information at the US Bureau of Economic Analysis (https://apps.bea.gov/iTable/iTable.cfm?isuri=1&reqid=62&step=2&0=1). I counted on my fingers and concluded that the US has had a goods trade deficit for 47 years. Wow. Turning around something that has been in deficit for 47 years could be quite an undertaking. The plot sickens -- I know it is supposed to be thickens but it really does get worse.

I used a graph from the St. Louis Fed (below) to show the goods trade balance since 1992. Notice some interesting things about that graph. First, the US goods trade deficit gets worse from 1992 to 2017. Second, the only thing that seems to improve the goods deficit is when we have recessions (vertical shaded areas in the graph) in the US that make us poorer and less likely to buy goods (both domestic made and imports). A cynic might conclude that recessions are great ways to reduce goods deficits, but one can plainly see that the remedial impacts of recessions are temporary. And that would be a very painful way to reduce deficits.

Let's suppose you lost undesirable weight gradually over a period of 25 years. We might conclude that extreme diets did not bring about that result. The continued desired loss of weight probably came because you made permanent and important changes in your life. And so it goes with goods trade deficits that have been around for 47 years and clearly worsening for 25 of those years -- there is something fundamental going on. And that something fundamental is not going to be easy to change.

We have had a lot of presidents and congresses in those 47 years, and it is probably true that not one of them organized a party to celebrate larger goods deficits. Yet, despite a lot of talk and some actions here and there, we are here in 2017 with goods deficits that seem to be getting bigger and bigger.

Let's suppose goods deficits are really bad for us. Then perhaps Trump's different approach to goods deficits is worth trying. Apparently his predecessors just made things worse. Their methods might have been sweeter and more humane but let's face it: if this is a problem, then sweetness may not be the best approach. If we want to reverse all those goods deficits, then it may take a fresh approach. You've heard of good cop/bad cop. Maybe it deserves a try.

Let's suppose, instead, that goods deficits are not so bad for us.  Seventy percent of our national output is services. We are very good at making and competing with services. Our services trade balance in 2017 was a surplus of $255 billion. As buyers we want goods and services. As producers we want to make services. So clearly -- we WANT a trade deficit in goods.

We also "export" a  lot of financial and real capital to the world. Maybe we should be focusing more on what we can do (services and assets) rather than what we can't (goods).

Saving: A Little Brush Fire?

While we have been arguing the last few weeks about tariffs, saving, and trade deficits, the Congressional Budget Office was preparing its Budget and Economic Outlook 2018 to 2028 (www.cbo.gov). It might not seem obvious how the CBO’s work relates to our tariff spat, so I decided to spend a perfectly nice Sunday morning tying the two together. The main idea is that our trade deficits have very little to do with cheating and everything to do with national saving. National saving has a lot to do with government deficits. 

Some of you don’t like the convoluted explanation that insufficient domestic saving (over-consumption) draws in foreign saving, raises the value of the dollar, and creates a (larger) trade deficit. It sounds much too theoretical. And you don’t see how Americans who love their lattes and other luxuries could ever behave like folks in other countries who actually try to balance their budgets.

But that’s all recorded in the past few weeks of blogs. If that hammer wasn’t big enough, I now want to bring the CBO’s latest sledgehammer into the project. Some of you are old enough to remember the world as it was in 2007 before the global recession slapped us around. In those good old days, a cup of coffee cost 20 cents and tasted like tea and most of us drank water from a tap in a thing called a glass. In 2007, the US budget deficit was $161 billion and the net national debt was $5 trillion.

Let’s back up. A government deficit is a one-year measure. In 2007, the government spent about $2.7 trillion, collected revenue of about $2.6 trillion, and sold government bonds to the public totaling $161 billion. Yes, when the government spends more than it collects in tax revenue it must borrow the difference. The $161 billion of 2007 was pretty typical of US government borrowing between 1999 and 2007 though it oscillated from year to year and hit a high of around $400 billion during one of those years.

The government borrows mostly from US savers. Borrowing $200 billion or so per year did not put too much stress on US saving. But imagine what happens when the borrowing rises from $161 billion in 2007 to $1.4 trillion in 2009. You are correct. That’s a 10-fold increase. If households and business firms are trying to borrow from savers at the same time, you can imagine how domestic saving might be insufficient or at least less sufficient to cover the borrowing. In such cases foreigners make up the difference. They bring their savings from countries around the world to the USA.

But wasn’t that $1.4 trillion government deficit a one-time thing? We had a huge and scary recession, and our government did what it was supposed to do to generate more spending in the economy – tax less and spend more. That’s true. And all looked pretty good as government deficits began to get smaller. Then along came two events: the Tax Reform of 2017 and the Bipartisan Budget Act of 2018. Between these two waves of the magic wand, we took the budget deficit from $665 billion in 2017 to $1 trillion in 2020 and $1.5 trillion in 2028.

John Maynard Keynes thought the government should use a deficit in short-term situations with the intent of stimulating output. The fiscal dividend of the rising output would be a surge in tax revenues and a decline in government spending. Viola – a temporary deficit then vanishes into thin air. Keynes would be scratching his head about how nearly a decade after the recession started we are still stoking the fires with larger and larger deficits.

What sorts of things are wrong with this situation besides causing Keynes to roll over in his casket? First, the government is gobbling up our saving in the USA and sucking even more in from abroad. This makes it harder for US firms to borrow, to expand, modernize, and otherwise raise productivity. Economists call this “crowding out” of investment spending. Second, these government deficits that reduce available saving raise the value of the dollar and hurt our trade balance.

Third, these government deficits accumulate. If the US borrows $500 billion one year and another $1 trillion the next, then in those two years it has added $1.5 trillion to the national debt. The US net national debt was about $5 trillion in 2007. By 2017 it tripled to just under $15 trillion. The CBO says it will rise to $29 trillion by 2028. What a ride! In 2007 the net debt was 35% of the national economy. By 2017 it rose to 77%, and by 2028 it will be closing in on 100% of the economy.

Keep in mind that these forecasts extrapolate from current law only. It is possible to imagine this government raising spending (or lowering tax rates) even more during the next 10 years. It is also a sure thing that the US will encounter another recession before 2028. Either of those eventualities will cause the deficits to bleed even more and the national debt to be taller than a giant beanstalk. 

Need I say more? Between households, firms, and our lovely government, we are spending our brains out and the impact is to lower national productivity and competitiveness. We have too little business spending on capital and a corresponding trade deficit. Are we sure we don’t want to tend to this brush fire? Whether it is the government or the consumer, can we not find a way to restore more balance between revenue and spending? I guess we can always start over after the fire ravages our nation. 

Cheaters, Saving, and Investment

It is easy and perhaps even fun to describe the US balance of trade as born of cheaters and clearly unfair to US workers. The logic seems simple and intuitive. We are a great nation, and yet we import more goods from other countries than we can export to other countries. If trade was perfectly fair, then, of course, Americans could not lose. After all, we are smart, educated, attractive, competitive, and whatever else you want to add. How could we possibly be so uncompetitive? Surely those other guys are cheating. End of story. Where is my celebratory JD?

Not so fast. Economists have another explanation, and it has to do with how much a country saves and invests. Whammo, the intuition vanishes and the reader is pretty sure that economists are from another planet. In defense, I will point out that intuition has an advantage when people decried the Earth flat. From anyone’s vantage point, the world did not look round. This “saving and investment thing” lacks intuition but that doesn’t make it wrong.

One more point. Some friends have told me that maybe saving and investment do matter to the trade balance – but there is no way to get Americans to consume less and save more. While it might seem like an uphill climb, the data in the table below suggest that the USA is an outlier. When compared to other countries and other regions of the world, we are second-class citizens of saving. Maybe if people understood that this imbalance is truly a problem we might begin to do something about it. If the choice was between a devastating trade war and inducing Americans to save more, might one not entertain policies to raise saving?

To review: If a nation spends more (and saves less) than its ability to produce then it will import the difference. Or put another way, the paucity of saving means that firms and government will have to draw in or borrow foreign money to meet its spending needs. This capital inflow raises the value of the dollar, increases imports of goods, and reduces exports of goods. Viola. A lack of saving leads to trade deficits in goods.

What do the numbers in the table show you?

First, I have 15 countries and regions listed in the table (data taken from an International Monetary Fund report). The highest saving rate among those 15 in 2017 was the 40.5% of GDP for emerging Asia. Just below are Japan and Germany with respective saving rates of 27% and 28%. The lowest in the list is the United Kingdom at 13.4%. At 17.5%, the US was in the third place from the bottom. We clearly do not save very much. I knew that Japan saves more than us by a long shot. But so do 12 of the 15 in the table. The average for all developing countries was 31.7%, and for all advanced countries, 22%.

We do better at investment. The almost 20% investment ratio for the US is bigger than our desire to save.  But in looking down the list, our investment ratio is bigger than only Germany, Italy, UK, and Sub-Saharan Africa. The average for developing countries was 32%; for advanced 21.1%. So we are a laggard when it comes to both saving and investment. Does the low saving retard investment?

What really matters for the trade deficit is how short our saving is relative to investment since that gap is the key to capital inflows as explained above. Half of the regions included have negative saving ratios – meaning that saving is less than investment and those countries will have capital inflows and trade deficits. Our saving deficit of 2.3% of GDP puts us in the middle of those countries with the (negative) deficit sign. So it looks like we are in the bottom third of the whole group when it comes to saving insufficiency as a percent of GDP.

If so many of these countries can have adequate savings, then why can’t we in America? Do we really need all that crap we buy? Are there no policies that might improve incentives for saving? 

Table. Saving and Investment as a Share of GDP, 2017

USA and Selected other Countries and Regions

	Saving	Investment	S-I
United Kingdom	13.4	17	-3.6
Sub-Saharan Africa	15.3	18.7	-3.4
USA	17.5	19.8	-2.3
Italy	19.6	16.9	2.7
Canada	19.9	23.3	-3.4
Advanced nations	22	21.1	0.9
France	22.1	23.1	-1
Spain	22.5	20.6	1.9
Emerging Europe	22.5	24.8	-2.3
Middle East, Africa, etc	25.2	26.8	-1.6
CIS	25.6	24.3	1.3
Japan	27	23.4	3.6
Germany	27.6	19.4	8.2
Emerging and developing nations	31.7	32	-0.3
Emerging Asia	40.5	39.6	0.9

Misinformation about Tax Cuts

Note -- On 2/10/17 I realized that the table below has an error. The error does not impact my points but it does attribute the largest tax rate to Bush 1 when it was really Clinton 2. The order of the names at the end of the table should be Bush 1, Clinton 1, Clinton 2. The order of the numbers in the column is correct.

There are two things in life that are certain: taxes and JD. Or something like that. There is a lot of buzz about coming tax changes. Most of us like tax rate cuts. They make us richer. Some of us want bigger cuts for the poor. Others want bigger cuts for corporations and the rich. Others want bigger cuts for farmers who export agricultural products. I don’t want to get into all that because it gives me a headache.

In fact, what I want to do here is to take one baby step. That step has to do with the idea of tax cuts and tax revenues. Tax revenues are important. Everything else the same (economists love to say that), a reduction in tax revenues causes the government to have a larger deficit and debt. Since our national debt is larger than a 2X T shirt at Walmart, we don’t want new policy changes that make it even larger. So policies have to be careful not to reduce government’s tax revenue.

We awaken from our slumbers when we hear politicians speak about large tax rate reductions. One proposal would reduce our corporate income tax rate to chicken feed. Another reduces rates for the average worker. Other proposals would undo tax penalties recently put onto the richest of us. This is tax rate reduction season.

But cranky old men and a few of their lady friends say, wait a minute, buddy. Tax rate cuts are going to reduce tax revenue, increase the national debt, and probably lead to higher weed consumption. And those armed with more vim than vigor point to that nasty Ronnie Reagan and his tax cuts and those tragic government deficits he caused. Never mind that Reagan was President before the Great War and no one (except Fuzzy) can actually remember 1981 – the proof is in the Key Lime Pie (with graham cracker crust).

Or is it? I decided to take out my Janis Joplin album, pour a nice JD over rocks, and look into this issue with my usual astute analysis of the data. That didn’t work since I was bowled over at how complicated it becomes to pour JD and type numbers at the same time. And I also realized that the issue has way too many dimensions. For example, tax revenues depend on how strong the economy is. And Reagan had two terms in which the composition of Congress changed. And then there is the nagging issue of how decisions about national government spending affect government deficits and debt.

So after nearly fainting I decided to limit the scope of my project. Whatever I say here, therefore, is subject to lots of ifs, ands, and buts. Nevertheless, the story is useful and perhaps adds to our discussion about tax cuts and government deficits.

One would think that if the Reagan tax cuts significantly bent tax revenues downward despite a subsequently growing economy, then we would have some good evidence against tax rate cuts. So I decided to look at historical changes in one number – tax revenues as a percent of GDP. The table below contains what I found. The table shows federal government tax revenue as a percent of GDP from 1969 to 2000. The average tax revenues as a percent of GDP during that 32-year period was 17.8%. In 2015 the number was 18.2%. The numbers in the table refer to averages over four-year presidential terms.

Table: US Government Revenues

as a Percent of GDP

Nixon            17.8

Nixon/Ford   17.4

Carter            18.0

Reagan 1       18.0

Reagan 2       17.5

Clinton 1       17.4

Clinton 2       17.7

Bush 1           19.0

Interestingly Reagan’s average for his two terms was 17.8% or exactly the average from 1969 to 2000 and was a smidge less than Obama’s rate in 2015 (not in the table). And Reagan’s tax numbers do not significantly look different from the other Presidents. Nixon/Ford and Clinton 1 managed to get tax revenues down to 17.4% of GDP while Bush 1, Carter, and Reagan 1 increased tax revenues to 18% or more.

So if Reagan cannot be identified in a mug shot of past tax rate offenders, then why were his budget deficit numbers so creepy? Why has Reagan become the poster child for tax cuts, larger deficits, and poor B-grade movies? The answer, of course, has to do with the other side of government – disco dancing. Ha! I meant to say expenditures or spending. If government deficits were larger under Ronnie R, then you need to dig out the data on spending. But why dig it out? If Batman didn’t do it, then it must have been Robin.

So if you want to be mad at Ronald Reagan for government deficits, then you need to discuss spending. During Reagan’s presidency, Congress was split. The entire eight years Reagan worked with a Democratic-controlled House and during his last two years the Democrats controlled both houses. Not to blame the Ds or the Rs, the fact remains that government with a big G let deficits swell. It was not Reagan and it was not Reagan tax policy. It was spending.

It might be fun to think about all this as we head into the next months. Many politicians have already sworn an oath on their Mickey Mantle baseball cards to not push Grandma over the cliff – that is, they are not going to reduce spending on one program by one cent. No matter how fast these programs are growing and no matter that Grandma has a rocket-propelled wheelchair with an iPhone and tablet. And don’t get me started on all this infrastructure nonsense that both parties are trying to foist on us.

Argue about tax cuts versus government spending all you want. That’s fun. But don’t for a minute think it is a slam dunk. Tax cuts are not your enemy, and if they have a way of creating more economic growth, they might be worth the risk. More government spending, however, is going to send all of us to an early grave. Cheers. 

Globalization and the Trumpaline

A trampoline is a thing you jump on. If you get really good at it you can do flips and all sorts of amazing gymnastic maneuvers. Right now everyone is jumping on Donald Trump so I thought I would jump on him too. Let’s call this a Larry Cannonball on the Trumpaline.

I will leave all the exciting stuff to other people and focus on the one thing that I think I know a little about – industrialization and globalization. Okay smarty pants – those are two things but in some ways they amount to the same thing because they are known to chew up jobs. Industrialization is a force that has been going on for centuries but it got a very hot reputation when it resulted in tractors replacing horses and plows. 

Ever since then we acknowledge that new technologies and innovations destroy jobs. Of course, we have also learned that while each significant industrialization phase creates its own destabilizing impacts the net result takes time and usually leads to not only more national employment but also higher wages and incomes.

Lauren’s great grandpa used to be the guy who blew out the candles in all the street lamps in Bloomington. Electricity knocked him out of work but that whole electricity thing also led to cool inventions like vacuum cleaners and blenders and pretty soon all sorts of people had great jobs as electrical engineers and bar tenders. If you take a big swig of JD, close your eyes, and think about your life you can easily think of all the labor-displacing inventions that caused similar disruptions but eventually came to be ho hum. I make light but these are no small things. When the textile industry abandoned the NE part of the US – it wasn’t very funny to those displaced by the invention of air conditioners that made work in the South more tolerable. Now we all say "yawl" and I "guarandamnteeit".

Most of us don’t fight industrialization very hard. We know it works. We like the fact that all those street lamps can be turned off with the push of one button and we like the fact that we can afford vacuum cleaners and bartenders. One of the reasons we have social programs is to try to make the transitions a little gentler. Helping those persons who become unemployed or otherwise disadvantaged by change is both good for the head and the heart. So we usually embrace change. Some of us love change but that is not necessary so long as society allows these transitions. The truth is in the pudding since not many of us are demanding a return to the horse and plow.

That brings us to globalization. Globalization is pretty much the same thing as industrialization except it allows us one more angle – the good guys (us) versus the bad guys (foreigners). Globalization is the same as industrialization because it does the same things – it creates havoc for some people while opening up avenues for growth and change for the rest of us. If a company closed operations in Indianapolis and reopened in Guadalajara Mexico you could hear the labor union and Donald Trump screaming all the way to the South Pole. How dare those blankety blanks leave Indianapolis to go to Mexico? They must be national traitors and they should be hung in the public square or in the Hoosier Dome.  Trump has made it very clear that he will make America great again by pulling all those companies back to Indianapolis and Detroit. Hillary Clinton is saying similar things. 

It sounds great. Let’s save American jobs. How can one argue with that? For one thing, it amounts to asking us to return to horses and wooden plows. Industrial transitions do not just occur in America. Now that dozens of countries are freer to compete in global markets the marketplace for change is everywhere. New ideas and innovations that improve our lives are developed and sold everywhere. To think that all that stuff would always be made in America does not make any sense. China will be the best place to make some items but even China is outsourcing output to Vietnam. Mexico will be a place of manufacturing for other things and they will outsource some of their supply chain to Chile. To think that Donald Trump or anyone else can or should fight globalization is silly.

For another thing fighting globalization means voting against change and the transitions that actually make American workers worth what they want to earn – close to $50,000 per year. We talk about greedy US companies who want to go to Mexico to take advantage of lower labor costs in Mexico. Now they are greedy. Yesterday and for how many years were those same companies employing American workers? Unions might complain about this or that but the truth is that many people raised families for decades because of the jobs offered by these companies. Were they greedy then? I don’t know whether they are more or less greedy today. What they are doing is fighting to succeed and in some cases to survive.  Competition across the globe is intense. To not change is to die.

So long as the average income of educated and/or trained workers in many emerging markets is less than $10,000 per year it is pure folly to think that US workers hired at $50,000 will offer the best place to do business.  To save the company and American jobs, a US multinational will move some operations out of the US. Of course to save the remaining jobs they will continually have to improve productivity of the domestic workforce or even the higher skilled jobs will be threatened. Think of wave after wave of enemy combatants coming after your defensive position. Building a bigger wall might work for a while. But what you really need is an advantage.

Trump vilifies other countries for trying to come into the global economy and for daring to compete with the USA. The only real solution to this challenge is not to regulate US companies but to unleash them. Making America great means American companies winning in the global marketplace. It means change and growth. Don’t tell me that centuries of US growth are over. Tell me we have a plan to empower US companies so they can do what is necessary to continue producing good jobs and incomes in America.  The world is not always a fair place. Making it even less fair isn’t the solution. We have so many advantages over emerging market competitors they are impossible to list. We should use them and quit bellyaching!