Trade Deficits: Are They Bad for the U.S. Economy?

In 2018, the U.S. posted an $891.2 billion trade deficit, the largest in the nation’s 243-year history.

That sounds bad – but is it?

Trade deficits are a natural part of healthy international trade. Most nations carry a trade deficit as a standard way of doing business. The size of a trade deficit is influenced by a variety of macroeconomic factors, including economic growth rates, currency values and savings’ rates. Policies that aim to reduce trade deficits typically constrain the diversity of goods being traded, raise costs on companies and consumers and have negative impacts to economic development.

Trade deficits typically reflect a solid, high-performing economy.

For example, Americans are prosperous enough to buy more imported goods from China than the Chinese can buy from the U.S., which creates a monetary surplus for China.

However, due to the lack of productive investment opportunities at home, China invests its profits in other countries, especially the U.S.  “In other words, money flowing out to pay for imports flows back in to help pay for productive investment in new capital,” says William D. Lastrapes, professor of economics at the University of Georgia.

When the U.S. economy is expanding, with low unemployment numbers and high consumer spending, the trade deficit tends to grow. The U.S. dollar is also generally stronger against other currencies in these situations, which also increases the deficit. For example, seven years after the U.S. signed NAFTA, the trade deficit hit an all-time high, yet unemployment had fallen to 3.8 percent—the lowest point in three decades.

Trade Deficits Reflect Healthy Trade

In short, trade deficits mean that international capital markets are functioning properly, driven by natural market forces that reflect efficient borrowing and lending around the world.

“Trade deficits do not imply a loss of American wealth, or that other countries are taking advantage of the U.S.,” states Lastrapes.

Trade deficits can be a problem if they are the result of excessive government borrowing in countries that are politically unstable and/or have weak economies. But for powerful, well-developed economies like the U.S., “trade deficits are not an inherent problem,” he adds. “In fact, we’re better off having trade deficits than imposing tariffs and restrictive trade policies to prevent them.”

In short, trade deficits mean that international capital markets are functioning properly, driven by natural market forces that reflect efficient borrowing and lending around the world.

Trade Deficits Built the U.S.

As a newly formed country, the U.S. relied on trade deficits to grow its economy. According to Stephen Moore, a distinguished visiting fellow at research firm Heritage Foundation, during a span of more than 100 years of colonial and United States history, “America ran a trade deficit in 95 years of those years,” he says. “By importing net capital, our country grew enormously, employed workers at high wages and developed a job and wealth creation machine that was rarely seen before.”

What does reduce trade deficits, however, is recession. When an economy contracts, so does the trade deficit. This happened most recently during the Great Recession of 2009, when the trade deficit fell by about 40% as the economy collapsed and $7 trillion of wealth was wiped out.

The Center for Strategic and International Studies indicates that the goods deficit with China reached an all-time high in 2018 of $419 billion, nearly half the total U.S. trade deficit. Even though this seems alarming, “we should not be too concerned about reducing the trade deficit,” state William Reinsch and Jonathan Robison, global trade experts with the Center for Strategic and International Studies. “The newly released data confirm what most economists have consistently argued—that the trade deficit is largely determined by macroeconomic factors and that simply imposing tariffs does not reduce the deficit. The deficit we should truly be worried about is the federal budget deficit, but that’s a whole different issue.”

Some opinions expressed in this article may be those of a contributing author and not necessarily Gray Construction.