This is a response from Rob Atkinson of ITIF to my post on Manufacturing and Trade Balances:
Recently Simon Lester and I got in a Twitter debate about the importance of the trade deficit and manufacturing. Interesting as far as these things go, but at some point you can only go so far in rational argumentation on that medium. So Simon wrote a short piece laying out his views, and invited me to do the same. Which I do here.
The dominant view in Washington, especially among conventional neo-classical economists, is that trade deficits don’t matter and they are caused by lack of national savings. This is a reassuring view to free-market believers because it means that the government doesn’t have to pick winners: in this case export-based manufacturing. If the trade deficit is not a problem, then there is no need for an industrial policy. And for them an industrial policy is anathema because it substitutes the wisdom of the state for the wisdom of the market; violating freedom in the process.
However, the massive U.S. trade deficit is a problem for two reasons. First the annualized accumulation of trade deficits means a massive trade debt that has to be paid back in the future by running trade surpluses. At some point, other nations will demand to be paid in goods and services, not ones and zeros (e.g., money). As such, it imposes generational unfairness because the future generation will have to consume less than they produce.
Second, the U.S. trade deficit reflects a loss of competitiveness in key industries. If you believe that potato chips, computer chips, what’s the difference, there’s nothing I can say to convince you that some indsutries are more key than others. Simon Lester appears to believe this when he says “the particular focus of a country’s economy on one sector or another is not a key long-term factor in determining the trade balance.”
Simon reflects the conventional wisdom when he says trade deficit is determined by U.S. savings. But this is only correlation, not causation. If the U.S. didn’t run trade deficits there would be less spending and more savings. Moreover, as a thought experiment consider doing all things neo-liberal free-market economists oppose: raising corporate taxes, breaking up big companies, and imposing massive burdensome regulations on U.S. companies. Do you really think exports would not go down?
Simon then states that the key issue is “whether government intervention with the goal of promoting more manufacturing in the U.S. would eliminate the trade deficit. This gets to the other factor Simon cites: currency. An “anti-competitiveness” policy regime would either jack up the trade deficit or we’d have the same trade deficit but worse terms of trade—a lower dollar. Both are bad for America and Americans. The former imposes cost on the future generations. The latter on current ones. So what I want is the United States running an overall trade balance, with a surplus in advanced technology goods and services, with a strong dollar. We have none of the three now.
But if you believe that America’s future cannot be one of shipping soybeans and importing tourists, then a trade deficit, much of caused by foreign countries wanting to outcompete America in advanced industries is a problem. It might be nice to live in a theoretical world where countries don’t try to exert power over each other and where America’s prowess at selling soybeans, movies, tourism and financial services gave us the same power a country (perhaps China?) that specializes in drones, computer chips, ships and aerospace. But that world only exists in fiction.
Finally, Simon says that “the existence of a trade deficit does not mean your economy is doing badly.” I agree. As I have written, there are three key factors determining an economy’s health: productivity, innovation, competitiveness, plus of course the business cycle. Most focus on the latter. Are jobs up or down, etc.? This is not unimportant, but in the medium to long-term it is much less important than the first three. The latter—competitiveness—matters because it determines either the trade balance or the value of the currency, and can determine the techno-economic strength of the economy. So of course, the U.S. economy might be performing well on one or two of these factors, but if it is not performing well on all four, especially competitiveness, it is not a healthy or sustainable economy.
Final point. Supporting manufacturing to lower the trade deficit doesn’t have to mean the dreaded “picking winners”. It could mean an investment tax credit and much higher R&D tax credit. It could be official policy to not defend the dollar. It could mean a regulatory system that spurs innovation.
