The Economics of Trade: Trade Deficits

In this post, Alan Reynolds takes issue with Billionaire investor Wilbur Ross, a supporter of Donald Trump, for making the following comment:

“It’s Econ 101 that GDP equals the sum of domestic economic activity plus “net exports,” i.e., exports minus imports.  Therefore, when we run massive and chronic trade deficits, it weakens our economy.”

In reality, the last sentence –beginning with “Therefore”– does not follow from the first.

By that logic, we should expect to see the economy weaken when trade deficits get larger and strengthen when trade deficits shrink or become surpluses. The data show the exact opposite (see chart and text here).

The main reason trade deficits are inversely related economic growth, contrary to elementary accounting, is that U.S. industry needs more imported parts and raw materials when the economy expands, and consumers can afford more imported luxuries when their incomes and investments are rising. A secondary reason is that whenever the United States is growing faster than the economies of major trading partners (such as Japan, EU, Canada), their demand for U.S. exports is likely to lag our demand for their exports.

Thanks for clearing that up.

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