Don Boudreaux On Why The Trade Deficit Might Not Be A Problem

This is something he posted at Cafe Hayek on 12-15-2010.

"Suppose Toyota sells a $20,000 car to an American and then immediately uses that $20,000 to buy software from Microsoft. Because the value of additional U.S. imports (a car) equals the value of additional U.S. exports (software), there’s no change in the U.S. trade deficit.

Now tweak the example just a bit. Toyota sells a $20,000 car to an American, then uses that $20,000 to buy stock in AT&T from another American. The American who sold the AT&T stock, in turn, spends the $20,000 on software from Microsoft as part of his effort to launch a new business. Because Toyota spent none of the $20,000 on U.S. exports, the U.S. trade deficit rises by $20,000.

Is the second situation worse than the first?

If the pronouncements of the mainstream media and of most politicians are to be believed, the answer is a resounding yes. A rising trade deficit is bad!

But look more closely. In both cases, Americans get an additional car worth $20,000, and Microsoft produces and sells additional software worth $20,000. In both cases, the amount of extra American-made output produced and sold as a consequence of Toyota selling that car to an American is the same: $20,000 worth of Microsoft products. If you’re a Microsoft employee, shareholder or creditor, it matters not a whit to you whether that company’s increased sales are made to foreigners or to Americans.

Clearly, a rising U.S. trade deficit does not necessarily mean less demand for American-made goods and services.

And as the above examples show, nor does a rising U.S. trade deficit necessarily mean that Americans are losing assets. While an American did sell $20,000 worth of stock to a foreigner, that American used the proceeds from the sale to invest in — to “grow” — his own company. If his company succeeds, that American’s net worth increases.

That American is richer, no American is poorer, and the American economy has more capital in it — all as a result of a transaction that raised the U.S. trade deficit."