It’s time to ditch our obsession with trade deficits. Here’s why

Arancha González Laya 2018

(International Trade Centre, 2013)

This article is brought to you based on the strategic cooperation of The European Sting with the World Economic Forum.

Author: Arancha González Laya, Executive Director, International Trade Centre.

The notion that trade surpluses are a measure of a country’s economic prowess dates back centuries. In 16th-century Europe, “mercantilists” from England to Venice sought to accumulate gold by promoting exports and discouraging imports. Their intellectual heirs today think trade surpluses boost national welfare, employment and economic growth, while deficits do the opposite.

The preoccupation with surpluses is based on dubious arithmetic: since one country’s exports are another’s imports, it is impossible for all countries to be net exporters. It also overlooks a more fundamental point about trade. The main benefit from trade is imports – foreigners sending the fruits of their labour for us to enjoy, allowing us to focus on what we do best. Working to produce exports is the price we pay to enjoy these benefits.

A better goal is to reduce the export effort needed to obtain a given quantity of imports. Economists call this “enhancing the terms of trade”. This makes intuitive sense in our own lives: you run a surplus with your employer in order to run deficits with your local grocery store, your daughter’s football league and your favourite restaurant. Now imagine if you could run those same deficits while spending only half as much time at the office.

Adam Smith recognized in 1776 that the true wealth of a nation was not the gold and silver in its coffers, but the productivity of its labour force. “Nothing can be more absurd than this whole doctrine of the balance of trade,” he wrote. Fast-forward to the present day, and his warning is once again going unheeded by policy-makers. Erecting protectionist barriers is unlikely to create jobs and prosperity, for two reasons.

 Three ways of looking at the US trade deficit with China (as % of GDP)

Three ways of looking at the US trade deficit with China (as % of GDP)
Image: Oxford Economics

First, current measures of trade on the basis of flows give a distorted view of bilateral trade balances, since they fail to account for components imported to make exported goods. Given the fragmentation of production across multi-country value chains, a far better gauge of a country’s trade performance is how much value it adds to inputs. Focusing exclusively on goods exacerbates the misperceptions since it excludes trade in services, which typically accounts for more than two-thirds of output in advanced economies.

Second, there is no straightforward relationship between a country’s trade balance and its economic health or labour-market dynamics. For example, US job creation since the 1990s has been fastest during periods when imports were growing rapidly. The trade balance narrowed dramatically in 2009 – mainly because GDP growth and job creation were plummeting due to the financial crisis, shrinking demand for imported goods and services. Germany has big trade surpluses rather than deficits, but manufacturing’s share of total employment there has been declining at more or less the same pace as in the US.

Percentage of employment in manufacturing in the US and Germany

Manufacturing jobs in the US and Germany
Image: US Bureau of Labor Statistics

Third, a country’s trade surplus or deficit is shaped less by the content of its trade agreements – tariff levels, quotas, regulatory rules and so on – than by the balance between domestic saving and investment within its own economy. Take the European Union: the entire bloc has exactly the same trade policy. Yet its member states perform very differently.

 Current account balance for European Union member states, as % of GDP, 2017

Current account balance for EU states, as % of GDP, 2017
Image: Eurostat

The current account balance – a broad measure of trade in goods and services that also includes net flows of income from foreign investments – is fundamentally a function of national saving and investment. Countries that run deficits spend more on imports than they earn from exports and borrow from the rest of the world to make up the difference. Conversely, surplus economies earn more from exports than they pay for imports; they lend the difference abroad, accumulating claims on foreigners in the process.

The only way to shift the current account balance is to alter savings and investment behaviour by households, firms and governments. Trade protectionism is an indirect way to accomplish this – but it could well miss the target or even backfire. For instance, when a country taxes steel imports, it hurts the export competitiveness of domestic makers of cars, planes, and anything else containing the metal.

Cross-country evidence suggests no clear link between tariff protection and current account balances. If anything, higher-tariff countries tend to have larger trade deficits. The World Trade Organisation rulebook authorizes countries to take protective action against import surges or predatory pricing, but while such measures can fight unfair trade, they have little effect on overall trade deficits.

Trying to tackle trade deficits bilaterally won’t work. Balancing trade with individual countries would, in practice, require constant interference with the purchase and sales decisions of thousands of companies and households, raising prices and generating distortions. Imagine if your supermarket had to buy something from you before it could sell you food.

None of this means policy-makers should ignore the existence of large trade surpluses and deficits. The cross-border financial flows these macro-economic imbalances entail are vulnerable to sudden stops that can destabilize countries and the global economy, as many Asian countries learned in 1997, followed by the Eurozone a decade later. But the solution is not trade restrictions: it lies in international cooperation to get countries that over-save to encourage more spending, and countries with big deficits to tighten their belts when circumstances allow it. The group of 20 leading nations is the logical forum in which to do just that. Similarly, broad negotiations among a number of countries are the most effective way to address unsatisfactory trade rules and industrial overcapacity.

Popular discontent over trade springs from genuine problems. Market-opening agreements have amplified technological trends that deliver outsized gains to small numbers of individuals, firms and regions. Closing markets solves none of these, but would hurt voters’ purchasing power, destabilize businesses and weaken future productivity.

Governments need to develop policies and institutions that cushion the blow from changes brought by both competition and technology, constrain runaway inequality, and equip people and businesses of all sizes to share in the opportunities presented by the global economy. This is the real challenge in trade. Current-account balances are merely a distraction – albeit one that could prove costly indeed.

the sting Milestones

Featured Stings

Can we feed everyone without unleashing disaster? Read on

These campaigners want to give a quarter of the UK back to nature

How to build a more resilient and inclusive global system

Stopping antimicrobial resistance would cost just USD 2 per person a year

Challenges facing the COVID-19 vaccination campaigns

Civilian deaths in Afghanistan hit record high – UN

Visiting North Korea, UN relief chief spotlights funding shortfall to meet humanitarian needs

Meet Alice, the battery-powered plane that could herald the age of electric air travel

Britain in and out of the EU

Statement by the Brexit Steering Group on UK government White paper

Cocaine and opium production worldwide hit ‘absolute record highs’ – major threat to public health says UN study

Ebola: EU releases additional €3.5 million to tackle epidemic

Voices of young climate action activists ‘give me hope’ says UN chief

European Semester 2019 Spring Package: Commission issues recommendations for Member States to advance sustainable and inclusive economic growth

Easing ‘classroom crisis’ in Côte d’Ivoire, brick by (plastic) brick

The United Kingdom’s decision to leave the European Union will impact young people’s future the most

5 ways COVID-19 has changed workforce management

Parliament to ask for the suspension of EU-US deal on bank data

Coronavirus Global Response: European Commission pledges €300 million to Gavi

Trump’s MAGA policy remains unchanged as EU warns to impose additional retaliation tariffs on US products

European Defence Fund on track with €525 million for Eurodrone and other joint research and industrial projects

COVID-19 creates a perfect storm for the extreme weather season

Healthcare for refugees: a necessary symbiosis of medicine and politics

EU climate law: MEPs want to increase emission reductions target to 60% by 2030

A geared turbofan at Pratt & Whitney's production hub in West Palm Beach (copyright: Pratt & Whitney - a UTC Company- 2018; Source: Pratt & Whitney's website, media center)

The EU Commission approves UTC’s acquisition of Rockwell Collins under conditions

Slovakia and its failure to abide by the European law

How to help an ageing population stay wealthy for longer

Soil pollution ‘jeopardizing’ life on Earth, UN agency warns on World Day

“Beyond the beach: tackling plastic pollution upstream”, a Sting Exclusive by Erik Solheim, Head of UN Environment

Google’s bare truth: Europe’s Chief denies EU accusations but admits they “don’t always get it right”

FROM THE FIELD: Persons with disabilities bike towards sustainability

Our health systems are under pressure. Here are 9 ways to remedy that

Hardware is a cybersecurity risk. Here’s what we need to know

Hatred ‘a threat to everyone’, urges Guterres calling for global effort to end xenophobia and ‘loathsome rhetoric’

What talent means in the post-COVID-19 workplace

What will Germany look like after the next election?

New legislation on transparency and sustainability of the EU risk assessment model in the food chain

This woman changed the world of work – and you’ve probably never heard of her

‘Grave consequences’ await if new deadly escalation of violence in Gaza continues – top UN official

The Dead Sea is drying up, and these two countries have a plan to save it

African elephants under continued threat of poaching, warns UN-backed report

AIESEC Vlog

Four million have now fled Venezuela, UN ramps up aid to children who remain

Ercom, cutting-edge Telco solutions from Europe

As ride-hailing firms drive into the future, who is being left behind?

Syrian crisis: €5.3 billion mobilised by donors for 2021 and beyond at 5th Brussels Conference

Carnage must stop in northwest Syria demands Lowcock, as attacks intensify

New round of bargaining for the 2014 EU budget late in autumn

Sudan: European Union provides €30 million in humanitarian assistance

At last Germany to negotiate the costs for a really cohesive Eurozone

UN evaluates progress in improving peacekeeping performance

The US + Britain trivialize mainland Europe, NATO and the EU

Khashoggi case highlights ‘very worrying practice’ of overseas abductions, says UN expert

What does global health translate into?

How Costa Rica’s environment minister talks to his daughter about climate change

Polluted lungs: health in the center of environment discussion

Here are 3 lessons Europe can learn from China’s flourishing start-ups

Geopolitics and investment in emerging markets after COVID-19

Canada needs to increase foreign aid flows in line with its renewed engagement

EU Ombudsman investigates the European Commission

Coronavirus: EU global response to fight the pandemic

SCADA Security Conference 2017 in Prague, Czech Republic

Brexit: Six more months of political paralysis or a May-Corbyn compromise?

COVID-19 vaccination campaigns and their challenges

More Stings?

Advertising

Speak your Mind Here

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s