On Trade Deficits: Murphy vs. The World, Part 2 of 3
In a previous post, I objected to Mark Perry’s own post about the U.S. trade deficit. The title of Perry’s post captures his point: “US has a net inflow of goods and a net inflow of capital. Team Trump wants the opposite?”
I pointed out that if a populist in Japan tried to impose schemes to keep Japanese savings “working for us here in Japan,” then surely Mark Perry and other free traders would object–and rightly so. But if a free trader would assure someone in Japan not to worry about their capital account deficit, then how can free traders assure Americans that a capital account surplus is self-evidently a good thing?
(For an analogy, if a free trader looked at kids swapping lunches at school, it would work to say, “Ah, you value what you got more than what you gave up. So this makes you better off.” But it wouldn’t work to say, “Billy got a cookie instead of spinach. And Team Trump wants the opposite?”)
Now Don Boudreaux defends Mark Perry over at CafeHayek. Don writes:
Mark’s point (in summary) is that if the voluntary economic decisions of Americans and foreigners result in a U.S. current-account (“trade”) deficit – which is to say, a U.S. capital-account surplus of the very same amount – Americans should not be upset. The reason is that a U.S. capital-account surplus means that the American economy is a net recipient, not only of imports, but also of capital. And being a net recipient of capital is not only not necessarily a bad thing for Americans, but is likely a good thing.
No, I have to cry foul. If *that* is what Perry had written, then you wouldn’t have heard a peep out of me. But as I took pains to emphasize in my original critique, that’s *not* what Perry wrote. There’s nothing in there about “…is likely a good thing.” No, go read Perry’s post again if you don’t believe me. Clearly, his argument is that it’s self-evidently a good thing when your country has (a) more goods and (b) more capital flowing into it than out of it. And that’s clearly not a good argument, unless you think all of the countries on the other side of the equation are in trouble and that their people should fret about the trade statistics.
But beyond me thinking that Don is being too generous to Perry in his summary of his post, Don and I actually have a substantive disagreement. Here’s Don:
I believe that Bob’s objection misses the mark. A capital-account deficit (that is, a current-account surplus) is indeed more likely than is a capital-account surplus to signal a problem with the national economy. If Japan consistently runs capital-account deficits, this fact is likely evidence that good investment opportunities in Japan are too few – and made too few by poor government policies that make the investment climate in Japan less attractive than it would be absent these poor policies.
I understand what he’s getting at, but I simply disagree. One last thing before I dive into my example. After reading Don push back against me, someone in the comments wrote: “Once again, you are confused. The current account deficit is not the same as the trade deficit.” To which Don gave an exasperated response, wondering how this guy could possibly think Don doesn’t understand this distinction.
OK, so now I’m going to give an example of what I think these critics have in mind. As I always say on these types of posts, on policy matters Don and I are in perfect agreement. But I think I see how Don sometimes is misunderstanding his critics, and they are talking past each other. So please keep that in mind when you try to understand, “What is the purpose of Bob giving us this scenario?”
THE SCENARIO:
A certain nation loves Adam Smith’s quote that what is prudence for a household can’t be folly for a great kingdom, and its people heed the wisdom of Deuteronomy 15:6 that says, “For the LORD your God will bless you as he has promised, and you will lend to many nations but will borrow from none. You will rule over many nations but none will rule over you.”
So in practice what happens is that the people of this nation save a large fraction of their income every year. After a while they have exhausted the great investment opportunities in their country and on the margin, it is more attractive to invest abroad. Thus, in a typical year, the people in this nation acquire more foreign assets on net than foreigners acquire of financial assets that are claims on the nation. That is to say, our hypothetical nation consistently runs large current account surpluses / capital account deficits, both in absolute money terms and as a share of their GDP. (The people always save a large fraction of their income, even as it grows rapidly because of their frugality.)
Now at first, you might think that this means our people end up sending more goods out of the nation than they import each year. But that’s wrong. What actually happens is that their nation runs a trade deficit while they nonetheless experience a current account surplus.
For example, in the most recent year the foreigners held (I’m converting to US dollars for our convenience) $10 trillion worth of foreign assets, in the form of bonds, stock, real estate, etc. That generated an income over the course of the year of $500 billion to our hypothetical people, because on average they earned 5% on their foreign assets.
In contrast, foreigners around the world only owned $4 trillion worth of assets in our country, in the form of corporate stock. (Remember, these people are wary of outside control, so they don’t issue bonds or sell real estate to foreigners. They do allow foreigners to buy shares of corporate stock in IPOs though.) These foreigners earn an average of 2.5% on their stock, meaning they earned an annual income of $100 billion.
Now in addition to these facts, I’ll report to you that our people sold $600 billion worth of goods to foreigners, while our people imported $750 billion worth of goods. In other words, there was a trade deficit of $150 billion. More goods flowed into the country as imports, than flowed out of the country as exports.
However, notwithstanding the trade deficit, there was still a current account surplus of $250 billion. That means our people had a capital account deficit of $250 billion. That is to say, our people invested (on net) $250 billion more in additional foreign assets than vice versa.
If you want to step back and see what’s happening: Our hypothetical people earned $500 billion in (gross) investment income from their foreign assets, and they earned an additional $600 billion from exporting goods. Then with that $1,100 billion in total income in foreign currencies, they paid $100 billion that they owed as corporate dividends to the foreign holders of their stocks, they bought $750 billion worth of imported goods, and with the remaining $250 billion they acquired additional foreign assets.
Now I’m not saying that this is necessarily the goal; certainly you wouldn’t want governments passing measures to try to achieve the above outcome. (For one thing, it’s impossible for every nation to be a net lender to every other nation.) But I think my example is the kind of thing that many of Don’s critics have in mind, and why they think free traders who keep telling Americans that a capital account surplus is a good thing, are missing something.
The nation in your example is like a rich person who earns so much money from rent and dividends that they can spend more than they earn from working while still accumulating additional wealth.
Given that the US runs a trade deficit while seemingly getting richer over time – isn’t this likely a pretty good description of the US economy and why Don isn’t worried about the trade deficit ? (Plus Don thinks that the rich person is also a seen as a good business manager and others will willingly invest in his business ventures).
This is precisely what is happening. Which is why US net income on foreign assets has been increasing along with the trade deficit.
“Given that the US runs a trade deficit while seemingly getting richer over time – isn’t this likely a pretty good description of the US economy and why Don isn’t worried about the trade deficit ?”
Our “trade deficit” should really be thought of as a debt, in that we can only “pay” for so many cheap foreign goods because we give them printed money.
A real trade deficit ends when the buyers run out of money. But the U.S. never “runs out” of printed money. And that’s not a good thing because we’re ripping off other countries.
We’re essentially stealing other countries’ goods with counterfeit money.
If we had sound money (commodity money), then there would be nothing wrong with our “trade deficit” – we’d go back to work when the money ran out.
(By the way, Peter Schiff did a podcast where he talked about how Trump was right to worry about our trade deficit, but, again, Schiff was actually describing just a regular debt.)
But I do agree that Don’s is stretching things a bit when he says:
‘If Japan consistently runs capital-account deficits, this fact is likely evidence that good investment opportunities in Japan are too few – and made too few by poor government policies that make the investment climate in Japan less attractive than it would be absent these poor policies.’
I think during the many decades of high Japanese growth these capital-account deficits were attributes of the economy (or rather individuals in the economy in the aggregate) becoming richer by producing more than they consume.
If you follow the trajectory of your fictional economy – initially when it has low capital it will have to run a trade surplus to accumulate foreign assets – its only when it has accumulated sufficient foreign (and domestic) capital that it will be able to move to the model you describe. I think China (if not Japan) is in this stage right now.
I read all the time that a preferred tax policy would tax consumption and not tax capital accumulation. The corollary to this is that a preference for consumption over capital accumulation is not preferred. If a trade deficit and the corresponding capital surplus means that we Americans favor consumption of imports over accumulation of capital why wouldn’t this also be evidence of something amiss? Bad government policy?. Or at least it show the existence of economically disadvantageous preferences by Americans?
Dr. Boudreaux says ” if the voluntary economic decisions of Americans and foreigners result in a U.S. current-account (“trade”) deficit – which is to say, a U.S. capital-account surplus of the very same amount – Americans should not be upset.” My instinct is to agree with this. BUT, if this is so then why can’t I also say: “if the voluntary economic decisions of American taxpayers and producers result in U.S. citizens favoring consumption over capital accumulation then American tax policy makers should not be upset.”
(and before someone else points this out, I do realize that my argument here is much weaker if the US is running a trade deficit because it is importing lots of capital goods. I don’t believe this is actually the case however)
“And being a net recipient of capital is not only not necessarily a bad thing for Americans, but is likely a good thing.”
What Don means is that for every 100 factory workers who lose their $50,000 / year jobs, one CEO will gain a $10 million bonus: net gain!
And when was the last time stinkin’ factory workers funded an all-expenses-paid trip to a libertarian convention at a tropical resort?!
“What Don means is that for every 100 factory workers who lose their $50,000 / year jobs, one CEO will gain a $10 million bonus: net gain!”
You worry too much about workers losing their jobs, as if that’s a bad thing.
Trade is not about workers, or even producers or CEOs – it’s about consumers because if consumers don’t buy goods, then neither workers nor CEOs make money. Consumers will go on consuming until they run out of things to consume, at which point they will begin producing and incentivizing job creation.
As Walter Block has noted, factory workers are investors in their skills, and if they invest poorly, they suffer loss like everyone else.
The factory worker is not entitled to a $50,000 / year job. On the flip side, he does not deserve to have his property taxed away through property taxes, or his entrepreneurial attempts squashed by zoning laws that tell him he can’t do certain kinds of work on his own property.