Probing Question: Does a Trade Deficit Hurt the U.S. Economy?

euro coins on red and black graph
Jose Ng

American pundits and politicians have long been vocal about the U.S. trade deficit, which has been rapidly increasing since 1997 and hit a record high of 763.6 billion dollars in 2006. Is the fact that America imports so much more than it exports legitimate cause for alarm?

Not necessarily, says Andrés Rodríguez-Clare, professor of economics at Penn State. To Rodríguez-Clare, trade, by its very nature, cannot be one-sided. "The more you import, the more you export," he says. "When you import, you are sending dollars abroad and then people turn around and use those dollars to buy U.S. goods." Eventually, he says, the relationship between imports and exports balances out.

Rodríguez-Clare likens a trade deficit to having a large mortgage on your house. "Is that a bad thing or a good thing?" he asks. His answer: It depends. If there's no hope of a reasonable return, it may be a bad thing. But "Taking on debt in the hope that an investment will pay off is something that can be good in the long run."

One reason some economists worry about the deficit is America's low rate of savings compared to the rest of the world. To make up for the lack of savings, Americans and their government have to borrow from other countries in order to buy consumer goods and make investments. This manifests itself in a trade deficit.

But whether U.S. investors are borrowing from the rest of the world to invest here or the rest of the world is investing here directly, Rodríguez-Clare says, the result is good for the American economy. Though such investment shows up as a trade deficit, he explains, it actually demonstrates economic strength. "Countries with stable economies and good rates of growth, like the United States, will naturally attract investment from the rest of the world," he says.

Conversely, Rodríguez-Clare adds, a trade surplus can sometimes be a negative sign. After Argentina's economic collapse in 2000-2001, that country had a trade surplus, he points out, because nervous investors and lenders pulled away from an Argentine market they viewed as unstable. As a consequence, Argentina's debt to other countries declined, but that didn't help its economic recovery.

Rodríguez-Clare cites a recent study by Harvard economists Ricardo Hausmann and Frederico Sturzenegger which posits that the very concept of a trade deficit is flawed. Hausmann and Sturzenegger found that although the U.S. trade deficit continues to grow, the national debt hasn't increased by much. The reason for this, they conclude, is that the U.S. makes a high return on its investments abroad because of the global popularity of its intellectual property, including inventions, software, movies and music. Foreigners, on the other hand, are willing to take lower returns on their investments in the U.S. because of the perceived stability of the U.S. economy. This discrepancy, Hausmann and Sturzenegger say, doesn't show up in the total trade deficit number.

Rodríguez-Clare says that bilateral trade deficits like the one the U.S. currently has with China are not really reflective of the overall trade picture either. Components of products are typically made in numerous countries to maximize efficiency, he explains, and that often doesn't show up in the numbers when two countries are compared.

As to concerns about the loss of American manufacturing jobs caused by imports of cheap manufactured goods, Rodríguez-Clare suggests that those losses, while unfortunate, represent necessary growing pains. "We shouldn't think about trade in terms of creating and destroying jobs, but as a transformation of jobs," he says. A dynamic economy means that while jobs are lost in manufacturing, they are gained in high-technology fields like the biomedical industry and software engineering. "I think that the U.S. has wisely chosen to let change happen and then deal with the negative consequences of trade-compensate people, help them find other jobs, help them in the transition," he says.

The economy as a whole benefits from free trade, concludes Rodríguez-Clare, despite the hardships that a changing economy creates for some individuals. "The negative side of trade is obvious," he notes, "while the positive often is not."

Andrés Rodríguez-Clare, Ph.D., is a professor of economics in the College of the Liberal Arts. He can be reached at andres@psu.edu.

Last Updated May 07, 2007