In November of 2004, the United States ran a fifty-four billion dollar trade deficit, translating to over 600 billion for the entire year. This deficit is a result of the disparity between the amount of goods that the US imports and the amount it exports. To equalize this deficit in its current account, the American government sells assets from its capital account, often to foreign investors. This phenomenon is seen as a serious threat to the success and continued growth of the nation’s economy, tied in with popular concerns that the United States is losing its competitive and dominant edge in global economics. The traditional economic theory employed to solve this problem calls for a return to mercantile protectionism, through use of tariffs and subsidies to drive up the price of imports and lower the price of exports. Running contrary to this is a second option: increasing domestic savings and lowering government spending. These theories both aim to decrease American dependence upon foreign imports and investment, and ultimately equalize the enormous trade deficit that currently exists.
A nation that possesses strong industry, a favorable trade balance, and a lack of dependency upon foreign states is optimum. This ideology is one that has been strongly advocated throughout America’s existence, by politicians from Alexander Hamilton to Pat Buchanan. When a nation faces a trade deficit, it means that competing states are producing more efficiently, and ultimately making profiting. Also, a deficit means that industry and jobs, which could exist domestically, are being “stolen” by foreign nations. According to mercantile policy, this is a zero-sum game; when a competitor is winning, we are losing. The United States faces this situation, having evolved from the world’s largest creditor nation during and following World War II to its current position as the world’s largest debtor. Because America imports much more than it exports, an additional 600 billion dollars is needed every year to balance the equation. This money is “borrowed” through the sale of government assets, sometimes to domestic investors, but increasingly to foreign ones. Many circumstances can be blamed for this situation: cheap foreign labor, foreign government subsidy, and closed foreign markets, among others. The question therefore arises: how to negate obstacles and protect American industry, while at the same time ensuring efficiency and the protection of consumers.
The first proposed solution to this problem is one of protectionism, following mercantile guidelines to minimize imports and maximize exports. This is done through government intervention in the market in three primary methods, tariffs on foreign imports, subsidization of domestic industry, and devaluation of the US dollar. Free trade leads to specialization, and America is unable to compete with other nations in many sectors of industry. Countries such as China, Japan, and Mexico can produce many goods at far cheaper prices, making it very difficult for domestic producers to compete.
Tariffs deal with this problem in two coinciding ways. First, the price of these imported goods goes up because of the tax the importers are forced to pay. Therefore, the original advantage of the importers is defeated, and domestic producers are able to compete, or even dominate the foreign competition. Second, the government takes in revenue from the tariff, adding to the money in its current account. Therefore, by reducing the necessity for imports the deficit is lowered, and the government, reducing the need for foreign investment, makes more money. Subsidization, the second means of government protection, allows domestic producers to lower their prices, and to make their goods more attractive in foreign markets. Although the government pays the difference, the amount of exports increase, bringing in increased revenue and helping to decrease the deficit. The third method in this scheme is to artificially devalue the dollar. Causing the dollar to be worth less compared to foreign currency has a similar effect to the implementation of tariffs, a weaker dollar means American goods can be exported and sold cheaper, raising the demand for them. Also, the purchasing power that Americans possess lowers, so demand for foreign imports declines.
Although protectionist policy is perhaps the natural reaction to a deficit, it contains several major problems that keep it from being a successful solution. When the amount of imports is artificially lowered below the market level, fewer dollars are available on the international market. Consequently, scarcity causes the dollar to strengthen, and foreign monies devaluate. This causes American exports to increase in price abroad, which leads to less demand for US products. Therefore, while the tariff reduces domestic desire for imports, it also reduces foreign desire for American goods, ultimately nullifying the intended effect. Any tariff reduces the overall volume of imports, as well as exports. This scarcity causes universal price increases, forcing the consumer to deal with the burden of protecting domestic industry. The implementation of tariffs and subsidies also has political consequences. Often, other nations react to tariffs by imposing taxes of their own, and act in the same manner in response to subsidization. Again, trade is limited, and prices increase. While a devalued dollar does increase the demand for exports while decreasing it for imports, it is not without cost. Weak currency means lower purchasing power, which results in inflation. Once more, the American consumers are forced to foot the bill, seeing their money become worth less in an effort to protect domestic industry.
Because mercantilist policies limit trade, they ultimately prove ineffective. A second proposed solution to the US trade deficit is a more moderated approach: decreasing the necessity of foreign investment, lowering the federal budget, and allowing free trade to work its natural course. The major problem with a sustained deficit is the necessity to sell capital assets, in order to balance the equation. This results in America owing huge amounts of borrowed money, as well as interest, to foreign nations and investors. By increasing the amount of domestic savings, the government has more of its own money, and less need to borrow from foreign sources. Coupled with reduced government spending, America is able to compensate for the difference in trade.
If dependency upon foreign investment is reduced, the trade deficit really loses its importance. According to Daniel Griswold, director of the Cato Institute’s Center for Trade Policy, a budget deficit doesn’t necessarily mean a weak economy. Over the past 28 years, while the deficit has consistently risen, so too has the size of the economy. In fact, US economic growth has been more consistent than that of Japan or Germany, nations that possess consistent trade surpluses . Because of this growth, America is a prime target for foreign investment. When other nations invest money in America, the price of the dollar remains strong. Again, the powerful dollar causes US exports to increase in relative price, while imports become comparatively cheaper. Therefore, not only does decreasing the amount of borrowed money reduce dependency, it will also keep the exchange rate more favorable for US products and suppress the domestic demand for imports. This happens naturally, as opposed to the protectionist policy of artificially lowering the strength of the dollar.
Increased self-reliance is a far more effective strategy for managing the US ledger, however, it can pose consequences of its own. If less foreign money is invested in the US, the price of the dollar does go down, and domestic industry is promoted. However, this lower exchange rate can cause inflation, and reduced spending power for American companies and citizens. Also, according to Griswold recent examples show that recessions coincide with a lowered deficit. This occurs because people spend less money, on foreign and domestic goods, and the economy slows down. This does reduce the deficit, however, a recession generally results in higher unemployment and negative reaction to the government’s performance. Despite these two possible results, this second solution proves to be the priority solution to solving the American “budget crisis” than a return to protectionist policy, which defeats the benefits of a free and liberalized market.
The United States currently does possess an enormous trade deficit, but the importance of this problem and the best means of solving it is a sharply debated issue. Clearly, while a return to protectionist policy would have some positive effects in the short run, it ultimately would undue the enormous growth that free international trade has caused for the US economy. The more moderate approach, of increasing domestic capital, reducing reliance upon foreign money and goods, and reducing government spending, deals with the situation much more effectively. A deficit is often times natural, especially in a wealthy country with a very strong economy, such as the US. Using these techniques, the negative aspects of the deficit can be overcome, while still ensuring the efficiency and affectivity of a liberal international trade system.
1.Griswold, Daniel. America’s Maligned and Misunderstood Trade Deficit, http://www.freetrade.org/pubs/pas/tpa-002.html
Balaam, David. Introduction to International Political Economy, Upper Saddle River, New Jersey, Pearson Education, 2005.