Trade Deficits Don't Necessarily Reduce The Rate Of Economic Growth

See Yet More Deficient Understanding of Trade by Don Boudreaux of Cafe Hayek.

"Here’s a letter to the editor of PoliZette:

Alan Tonelson’s insistence that America’s trade deficit is a drag on economic growth is itself a drag on economic understanding (“You Bet America’s Trade Deficits Matter,” June 15).  To put it bluntly, Mr. Tonelson doesn’t know what he’s talking about.
Consider his assertion that “mainstream economics has long held that when a nation’s trade balance worsens, its economic growth slows.”  First, no less an economist than Adam Smith demonstrated in 1776 that worries about a nation’s ‘balance of trade’ are foolish.  Smith concluded that “Nothing, however, can be more absurd than this whole doctrine of the balance of trade.”*

Second, apart from alluding to a connection between recent U.S. trade deficits and the slow recovery from the Great Recession, Mr. Tonelson offers no evidence that trade deficits dampen economic growth – perhaps because no such evidence exists.  For example, as my Mercatus Center colleague Dan Griswold documented in a 2011 study, “since 1980, the U.S. economy has grown more than three times faster during periods when the trade deficit was expanding as a share of GDP compared to periods when it was contracting.”  (Also, Mr. Tonelson’s assertion is difficult to square with the fact that for nearly all – in 102 of the 120 months – of the Greatly Depressed 1930s America ran trade surpluses.)

The likely explanation for Mr. Tonelson’s confusion is that he realizes neither that a significant portion of American imports are inputs used to boost production in America (including manufacturing) nor that a rising trade deficit means more foreign investment – more capital – flowing into America.  In practice, these inflows of capital signal that investors are optimistic about the future of the U.S. economy as well as themselves serve as sources of job creation and economic growth in the U.S.

Sincerely,

Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

* This quotation appears in An Inquiry Into the Nature and Causes of the Wealth of Nations, Book IV, Chapter 3, Part II, paragraph 31."