March 24, 2005

Trade Deficits

Based on the recent exchange at Cafe Hayek on the trade deficit (see string on trade here) I'd like to throw in my own take.

1) The trade deficit is simply recognizing a basic fact - the poorer parts of the world are getting richer. Since most of the money has been concentrated in the developed countries, that's where most money is located. Simple, right? Wealthy countries have wealth. What happens when poorer countries start getting more money, though? Naturally some of the wealth of the richer countries tends to level out. This is a natural process. If anything, it's a positive-good, not simply a value-neutral process or a necessary-evil sacrifice.

We should be happy that other countries are getting more wealth because it means they can have more luxuries, choices, medical treatment, and in general better access to the limited resources of the world. It's just a part of globalization.

As people in Chile, Costa Rica, Taiwan, India, and elsewhere have more money and industrial capacity they start producing more things that Americans and Westerners want to buy. So developed-country money goes to somewhat-developed and recently-developed countries - thereby encouraging further development.

2) Economics is a positive-sum game, not a zero-sum game. If you were to buy a product or service from a guy in India, as Don Boudreaux did in his example, it means that you got at least even value for your money; you got at least as much product as you were willing to give for it. If it cost more than you were willing to buy then you wouldn't have bought it. So simply put, the widget (an economic term for a non-specific product) you bought from India was worth at least as much as you were willing to pay. More likely, Don Boudreaux would've paid more than he did pay, since he could've shopped around on prices and bought one of the lower ones.

Let's say he saved $10 buying the Indian's widget instead of a widget from a woman in Thailand, which he would've bought had the Indian widget not been available. In that case, he added $10 of value to the overall US economy, because the widget was worth more than he spent. Don Boudreaux won in this exchange because he saved money and fulfilled his need. Even if he saved no money, he at least fulfilled his need, which is a positive outcome.

But the Indian also won. He agreed to sell the widget for the price Don Boudreaux paid. If the overall deal was unacceptable he would've done it. Even if he spent more acquiring the widget than what Don paid, the Indian at least minimized his loss. Let's assume a more common scenario, that the Indian made at least a minor profit on the sale compared to the cost of the widget; we'll say he made it for $10 less than the price Don paid for it. If this is so, then the Indian definitely won. In either case, he improved his lot - whether he turned a profit or minimized a loss.

We'll stick with the idea that Don saved $10 buying the cheaper widget and that the Indian made $10 over what he paid to make it. Both men won, because economics is a positive-sum game.

The only ‘loser’ is the Thai woman. She’ll either have to lower her price or wait for someone willing to purchase at her price. This is the same pressure that keeps retailers from selling at high prices; even though she’s only one person, her position might as well be an outlet store or a corporation. If she doesn’t find a more buyer-friendly price, then she might have trouble selling. The lack of a sale discourages her from selling unpopular models of the widget, or from using overly-expensive or inefficient methods of producing widgets. This is the self-regulatory nature of the market, which is of course imperfect as are nearly all things human, but certainly works well to find a price acceptable to BOTH parties in a transaction, not just the producer/seller.

How can a trade deficit be bad as long as it's based on substantively voluntary associations? Did the US economy lose here? Don introduced an additional $10 worth of value, even though he sent actual dollars away. The US economy - the collection of resources held and controlled by Americans - improved $10-worth because of his decision. At the same time, the Indian economy improved $10, despite the loss of the widget, because of the Indian's sale to Don. Everybody in it won.

If this is the trade deficit then what's the problem?

3) Now it gets a lot more complex if you introduce debt, which I believe was Warren Buffett's complaint on the trade deficit. The critique usually is, "what if foreigners call in the debt in a short period of time?" or something to that effect. Well, what if? The debt is a pretty complex mechanism, and a lot of US debt is underwritten by foreigners (why not? we're a good investment).

As long as the various debts called in are paid off, then the US economy probably benefited from delaying payment? It only makes some real negative difference if the economic actors that made the debt promises don't follow through. Most likely the debts would be paid off. As long as the US debtors were able to break even or benefit from taking the debt compared to if they had bought their products outright at the start, then the US economy wins the transaction. Assuming the creditors charged enough interest to justify taking debt notes instead of full payments from the outset, they win as well. So what's the issue? Again, everybody won – given these caveats. Yes, maybe we’d win even more if we had even longer to pay off the debts, but considering we still benefited, that’s ancillary in my view.

I think this is mostly emotional and territorial. Foreigners aren't going to simply call in all the debt at once because they will make their money back anyway. US money going abroad is a good thing for foreigners and a sign that Americans got at least even-value for their dollars. So it's a good thing, as good as any other voluntary economic transaction.

4) Americans and Westerners have a lot of money. Many foreigners don't. This means that foreigners often don't have the money to buy our large TVs, cars, iPods, DVDs and the like. We, however, have the money to buy the things they produce - whether they're cheap or expensive. We have the money to buy most anything they make; developing-country locals don't have the money to buy many of the things we make. Is it any surprise, then, that most of our transactions with the developing world involve us buying and them selling?

Americans are a great market - we're rich and affluent, and we like good stuff made cheaply. We buy a lot. So American companies and foreign companies tailor a lot of their industrial capacity toward selling something Americans and Westerners will buy. People in poorer countries, however, are much worse as a market. They don't have the money (and the laws) or the stores that encourage consumption like America does. They're not as good at consuming, so American companies and foreigner companies don't spend equal time tailoring their goods to sell to developing countries.

The trade deficit is a sign that we're a much better consumer market than other countries. Everyone sells to us, because we're great consumers. There's a lot more money selling cars and electronics to Nebraska than selling cheap shirts and baby formula to Nigeria. The trade deficit just reflects an obvious fact: the US is the best consumer-nation.

At the same time, the trade deficit reflects US money moving to the developing world. Eventually these other countries will be better consumers than they once were. This is already true of the four Asian Tigers; the per capita GDP of Singapore and Taiwan are now both in the $23,000 range - greater than Spain, New Zealand, Greece, Israel, Portugal or the Czech Republic. They are now in a condition where the low-wage factory jobs tend to go to China and Thailand, where it's cheaper, while Taiwan and Singapore become essentially developed countries that are consumer-countries in their own right.

So let's just remember these four things:

1a) Economics is a positive-sum game; all participants in a transaction can improve their position at once.

1b) The importance is not just actual dollars, but the relative value of both money and goods/services put in the economy.

2a) The trade deficit reflects the natural order of the US as the top consumer-nation, which is good.

2b) The trade deficit reflects the natural process of wealth spreading to the rising developed world, which is good.

The next time somebody starts fear-mongering about the trade deficit, just remind them that every dollars sent abroad was replaced by at least one dollar of goods and services coming into the US economy.

(I’ve added most of this blog entry to my website as an issue article, except for the part on the debt, and it can be found here.)

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