Don’t be spooked by trade imbalances, they’re the new norm
Is it better for a country to have a trade deficit or a trade surplus? For many people – including the new president of the US, Donald Trump – the answer is clear. A trade deficit is a “bad thing” as it means a country is selling less on world markets than it is buying. If a country could sell more goods and services abroad, there would be more jobs and the economy would be stronger.
The problem with this view of the world is that not all countries can run a trade surplus. If some countries have surpluses, then others must have deficits. Across the world economy as a whole, exports must equal imports. The planet Earth cannot run a trade deficit with the moon or Mars.
The US has a relatively large trade deficit. It was over $500bn (£409bn) last year and has averaged around the same level – half a trillion dollars – since 2000. The mirror image of the US deficit can be found in two other countries – China and Germany. China runs a trade surplus in goods and services of close to $300bn and Germany runs a surplus of over $250bn. South Korea has the next biggest surplus, but it is the only other country in the world that has a trade surplus or deficit of over $100bn.
So there are a small number of large economies which account for the big trade surpluses and deficits across the world economy. These countries, however, are the major players in the global economy. The US and China are the top two economies in the world and Germany is the fourth largest.
But whether a country has a trade surplus or a trade deficit does not have a clear cut impact on its economic position.
The Organisation for Economic Co-operation and Development projects that the US will be the world’s biggest exporter of goods and services this year – despite its large deficit.
And if a country has a trade deficit, its consumers are doing very well – they are spending more than the economy is producing. The only sure-fire way to cut a trade deficit is to squeeze consumers very hard – which I am sure is not something that President Trump has in mind.
What of the other ways in which the US or any other country might try and reduce its trade deficit? There are three possible policy approaches, and President Trump and his advisers have mentioned all of them in their recent policy statements. But the most effective direction requires long-term and consistent government action. There are no quick fixes to correcting trade imbalances.
The first possible approach is protectionism – imposing tariffs or physical restrictions on imports to try and redress a trade imbalance. History suggests that would be disastrous as it leads to retaliation and a general decline in exports and imports.
The second approach is trying to adjust currency values. Some countries have been accused of engaging in “currency wars”, including China, Germany and Japan.
But the reality is that governments and central banks have limited influence over currency values – which are set by investors taking views on economic and financial data.
The third approach to reducing a trade deficit is to try and improve the longterm conditions for business and wealth creation.
That is likely to be the most effective direction – but it can only succeed if the right policies are pursued over many years and decades.
The areas where the US needs to improve its performance are clear – investing more heavily in transport infrastructure, upskilling the workforce and reforming the tax system to make the US more attractive for investment.
It is good news that two out of three of these issues are clearly part of President Trump’s agenda.
He is committed to supporting infrastructure investment and tax reform, but it is not clear what policies he will promote and support on skills and education.
In all these areas, however, a long-term and consistent focus will be needed to change economic performance.
And we are still unclear about the exact policies which President Trump will pursue under his presidency – there is no legislative programme yet agreed with Congress.
Trade deficits and surpluses can be emotive issues – but we need to learn to live with them, particularly when they arise between the large economies in the world which are well able to sustain financial imbalances.
In the case of the US, it has two big related advantages. Its economy is still the largest in the world and the dollar is still the world’s reserve currency.
As a result, the US can run a trade deficit on a scale which would be unsustainable for other economies.
In my view, President Trump’s strategy should be to focus on the underlying causes of the US trade deficit rather than looking for quick fixes.
Protectionism and “currency wars” are not the solution to global trade surpluses and deficits. We now live in a highly integrated world economy where surpluses and deficits should be regarded as the norm rather than the exception.
The UK also has a modest trade deficit which should not be cause for alarm.
But the policies we should pursue are very much those I would recommend for the US – invest in infrastructure and skills, and reform the tax system.
Over to you, Philip Hammond, for action in next week’s Budget. Andrew Sentance is a senior economic adviser at PwC and a former MPC member
‘Protectionism and currency wars are not the solution to global trade surpluses and deficits’