Economics--The Dismal Science Part Two--The Trade Deficit

Deficits aren't all bad, part two.

The next one is the Trade Deficit which a lot of people, mostly politicians, pick up as bad because we are outsourcing our jobs.  That is true--an autoworker in Detroit is going to get outsourced to an autoworker in Seoul.  That is economic reality as harsh as it may sound.  And autoworkers have, as we used to say in the risk management business, long tails.  They stick around a long time and get a lot of benefits that cost a lot of money and they get paid if they don't work and go into a job bank.  I'm not knocking the autoworker--if the union can get the deal, ok.  But the 'invisible hand' of economics will do it's job and eventually GM and Ford will go away or form an 'alliance' or go bankrupt.  As one economist said,  "GM has been trying to go broke for a long time."

The autoworker's kids are more likely to be working at HP or an oil company or McDonalds and not flipping hamburgers.  They are probably management. 

But before we get into a big argument about job sourcing, let's look at some facts or, as they say, empirical evidence.  Do you want to live in an economy that has a trade surplus or a trade deficit?  You can pick to live in either the UK and the US or Japan and Germany.  This is for economic reasons only--a preference for sushi or beer is not allowed.  Economically, I pick the US and the UK.  And both countries have run trade deficits for the last 25 years.  Germany and Japan have been in a trade surplus mode for the last 25 years.  GDP growth in the UK and the US has been about double that of Japan and Germany.

So a trade deficit is good?  Well, again, the empirical evidence says that it is all not bad.

Where does the money go?  We buy goods from China, say, and we pay for it.  That's the current account deficit of which the trade deficit is part.  And then the money comes back into the US and the UK as a capital account surplus.

Huh?  The Chinese and everybody else send the money back to buy bonds and stocks and sometimes, US companies.

This is often painted as a great trap and the Chinese and everybody else are setting us up and they will pull out all their money at the same time and we collapse.  That's pretty smart.  Or another viewpoint is that they like us and want to invest here so we can run up credit card debt buying their stuff.  Maybe.

I don't think either one is correct.  People invest THEIR money where they believe they will get the highest return.  If everybody decided to pull their money out tomorrow where would they put it?  Switzerland?  I don't think so.

Foreign investors invest here because they get higher returns here because of our economy, our infrastructure and, most importantly, our innovation.  As long as we innovate we will attract capital and the deficit will not matter.  Put in trade restrictions or stunt innovation in some way (I don't really know how but somebody will think of something) and watch out.

Conspiracy theorists can jump all over this but it is the way the world works.  When you trade with somebody, you have a partner.  When you don't, you have an enemy.

Comments

[elizabeth ekpo]

i'd like some reasons why economics is and isn't a science
thanks

[wolfgang]

here's another way to think about problems like this: can the situation go on as it is indefinitely? i'd say no, so that would make it an unstable situation. we either run out of money or make new money to buy more goods/services, neither of which is particularly good. i also take issue with your statement that the money comes back when it flows into treasuries - the mass collection of treasuries just creates more money drains (interest) and unless the us defaults they do eventually have to be paid back.