No economic artifact is as responsible for more confusion and bad policy as is the so-called “trade deficit.” President Donald Trump, of course, frequently rails against the U.S. trade deficit, citing it as evidence of economic weakness at home, of nefarious trade practices abroad, and of the need for trade restrictions.
Yet nearly everything Trump asserts about the trade deficit is wrong and often the opposite of the truth. But to be fair, the president’s confusion isn’t unique to him; it’s widespread. We need to bust a few myths about the trade deficit:
Myth No. 1: U.S. trade deficits mean that demand for U.S. outputs is too low to maintain full employment.
This assertion comes from the fact that a U.S. trade deficit means that foreigners buy less from us than we buy from them. If foreigners bought more of our exports or if we bought fewer of their exports, it would appear that we could then produce more in America - and, hence, employ more Americans.
This appearance is false. Those who fall for this illusion fail to realize that the dollars foreigners don’t spend buying our exports are instead invested by foreigners in the United States - in factories, retail stores, research and development, real estate, etc. Some dollars invest in U.S. equity, while others become loans to Americans. These investments promote economic growth and job creation here at home just as much as investments made in America by Americans.
Here’s an accounting identity: A U.S. trade deficit (or, more precisely, current-account deficit) is always exactly offset - down to the last cent - by a U.S. capital-account surplus. This surplus means that America attracts a net inflow of global investment funds. Far from being evidence of American economic weakness or foreign hostility toward America, this surplus is evidence of American economic strength and of foreign confidence in America. Rather than lament U.S. trade deficits, Trump should boast about those that occur on his watch.
Myth No. 2: U.S. trade deficits push Americans further into debt to foreigners.
While some portion of the U.S. trade deficit does indeed become debt - as when foreigners lend dollars to Uncle Sam - not all of it does. For example, if the U.S. trade deficit rises as a result of foreigners investing in U.S. equity, as when Ikea builds a store in Iowa, there’s no corresponding increase in Americans’ indebtedness. No American owes Ikea shareholders, or anyone else, a single cent as a result of Ikea making equity investments here.
If the value of Ikea’s U.S. investment rises, it does so because Ikea creates value in the form of improved furniture retailing. Ikea’s profit is its own creation; it’s not a repayment from Americans. If, instead, Ikea doesn’t create value or earn profits, its shareholders suffer losses. Either way, this and other equity investments by foreigners - while they raise the U.S. trade deficit - don’t raise Americans’ indebtedness. The same is true when non-Americans hold dollars and buy U.S. real estate.
Myth No. 3: U.S. trade deficits reflect American consumers’ reckless profligacy.
This fallacy springs from an exclusive focus on imports and exports. If the value of what we buy from foreigners exceeds the value of what we sell to foreigners, it’s easy to assume that we’re spending beyond our means. Not true.
First, well over half of American imports are inputs used here by U.S. producers. They aren’t consumption goods; they’re raw materials, component parts, and machinery that increase the output produced by American farms, factories, laboratories, and other businesses.
Second, because many foreign investments in America are entrepreneurial ventures conceived and executed by foreigners (again, like Ikea), a significant portion of U.S. trade deficits are driven by foreigners taking advantage of the open-ended opportunities offered by the dynamic and relatively free U.S. economy. Blaming all increases in the U.S. trade deficit on Americans’ profligacy - or, for that matter, on unfair trade practices abroad or free trade generally - masks the reality that foreigners actively seek opportunities to invest in America.
While it’s theoretically possible that U.S. trade deficits could result from poor economic decision-making by Americans, in practice the opposite is true. The United States remains a distinctly attractive place to invest. We should be proud and celebrate, rather than bemoan, the fact that our global trade results in persistent U.S. trade deficits.
Donald J. Boudreaux is professor of economics at George Mason University and Getchell Chair at George Mason’s Mercatus Center.